Cannabis dispensaries face a unique tax situation. While most businesses pay 21% to 35% in federal taxes, dispensaries can often pay 60% to 80% of their profits to the IRS. This crushing tax burden stems from Section 280E of the tax code, which prevents businesses selling federally illegal substances from taking normal business deductions.
Making matters worse, limited banking access means many dispensaries operate primarily in cash, creating additional challenges for tax payments. Despite these obstacles, there are legal, compliant ways to file and pay federal taxes while minimizing your liability.
This guide breaks down how dispensaries pay federal taxes, walks through the specific tax forms, payment methods, and strategic approaches dispensaries need to navigate federal tax obligations successfully.
Table of Contents:Â
- What Makes Federal Taxes Different for Dispensaries?
- What Are the Federal Tax Rules for Dispensaries?
- How Do Dispensaries Pay Federal Taxes?
- Deductible vs. Nondeductible Expenses Under Section 280E
- How to Pay the IRS When Banks Say “No”
- Strategies to Reduce Federal Tax Burden Legally
- What to Do if You Can’t Pay in Full
- How to Stay Compliant Year-Round
- The Bottom Line
What Makes Federal Taxes Different for Dispensaries?
The federal government classifies marijuana as a Schedule I controlled substance, making it illegal at the federal level despite state legalization. This classification triggers Section 280E of the Internal Revenue Code, which states:
“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business consists of trafficking in controlled substances.”
This means dispensaries can’t deduct ordinary business expenses like:
- Rent and utilities
- Marketing and advertising
- Employee salaries (except those directly involved in production)
- Insurance premiums
- Legal and professional fees
The only deduction cannabis retailers can take is Cost of Goods Sold (COGS), which typically represents just a fraction of business expenses. State taxes generally follow more reasonable rules, often allowing normal business deductions and applying standard tax rates.
What Are the Federal Tax Rules for Dispensaries?
Cannabis businesses must follow several key federal tax requirements:
Schedule I Status Effects: Because cannabis remains federally illegal, the IRS applies Section 280E, which was originally created to prevent drug dealers from claiming tax deductions.
Limited Deductions: Only direct costs of purchasing or producing inventory (COGS) can be deducted. Operating expenses that other businesses routinely deduct are disallowed.
Cash Reporting: Dispensaries receiving more than $10,000 in cash in a single transaction must file Form 8300 within 15 days. Failure to file can result in penalties up to $250,000 and criminal prosecution.
Quarterly Estimated Payments: Despite banking challenges, dispensaries must make quarterly estimated tax payments based on projected annual income.
Payroll Tax Obligations: Even with 280E limitations, dispensaries must withhold, report, and remit payroll taxes for all employees, including income tax withholding, Social Security, and Medicare.
How Do Dispensaries Pay Federal Taxes?
The tax forms dispensaries file depends on their business structure:
Sole Proprietors file Schedule C with their personal Form 1040. While they report all business income, Section 280E limits deductions to COGS only. This often results in paying self-employment tax plus income tax on amounts that far exceed actual profits.
C Corporations file Form 1120 and pay a flat 21% corporate tax rate, but only on income after COGS. Without normal business deductions, taxable income is artificially inflated.
S Corporations file Form 1120-S, with profits passing through to shareholders’ personal returns. The 280E limitations apply at the business level before determining the pass-through amount, often creating substantial personal tax liabilities for owners.
Partnerships file Form 1065, with profits flowing to partners’ individual returns. Like S corporations, 280E disallowances occur before calculating each partner’s share of income.
For all entity types, the inability to deduct normal business expenses means dispensaries pay taxes on much more than their actual profits.
Deductible vs. Nondeductible Expenses Under Section 280E
Understanding what qualifies as Cost of Goods Sold is critical for dispensaries:
Deductible COGS Expenses Include:
- Purchase cost of products for resale
- Freight-in costs to acquire inventory
- Direct materials used in production
- Direct labor for production workers
- Certain quality control costs
- Packaging materials
- Some inventory storage costs
Nondeductible Operating Expenses Include:
- Rent and utilities for retail space
- Marketing and advertising
- General administrative salaries
- Sales staff compensation
- Insurance premiums
- Legal and accounting fees
- Software subscriptions
- Travel expenses
- Staff training
For dispensaries that both grow and sell cannabis, proper cost accounting becomes even more important. Cultivation and manufacturing costs typically qualify as COGS, while retail selling expenses don’t.
How to Pay the IRS When Banks Say “No”
Dispensaries have several options for making federal tax payments:
Electronic Funds Transfer: If you have a bank account, the Electronic Federal Tax Payment System (EFTPS) is the preferred method. You’ll need to enroll at EFTPS.gov and allow 5-7 business days for processing before making your first payment.
Money Orders or Cashier’s Checks: For payments under $1,000, you can use money orders. For larger amounts, cashier’s checks work, though you may need to purchase multiple checks due to bank limits.
Retail Partners: The IRS partners with retail stores that accept cash payments through the PayNearMe service. You’ll need to generate a payment code through the IRS website first, then bring cash to a participating location.
In-Person Cash Payments: For large cash payments, schedule an appointment at your local IRS Taxpayer Assistance Center. Call 844-545-5640 at least 30-60 days before you want to pay. The IRS will limit appointments to $50,000 per payment.
Remember that cash transactions over $10,000 require filing Form 8300 within 15 days. This applies to both single payments and related payments that total over $10,000 in a 24-hour period or connected transactions within 12 months.
Strategies to Reduce Federal Tax Burden Legally
While 280E creates significant challenges, several strategies can help minimize tax liability:
Precise Inventory Accounting: Use absorption accounting to maximize COGS by properly allocating indirect production costs to inventory. This requires detailed recordkeeping but can significantly reduce taxable income.
Separate Business Entities: Consider creating two separate companies—one handling production (which can deduct more expenses as COGS) and another for retail operations. This structure must have legitimate business purposes beyond tax savings.
Employee Stock Ownership Plans (ESOPs): These qualified retirement plans can create tax advantages while also helping with employee retention in a competitive industry.
Cost Allocation Analysis: Work with a cannabis-specialized CPA to analyze which employee activities directly relate to inventory handling and production. Properly documenting these activities can help allocate more labor costs to COGS.
Payroll Management: Using a specialized cannabis payroll software like Hybrid Payroll can ensure proper tax withholding, reporting, and remittance while maintaining detailed records that support your tax positions.
What to Do if You Can’t Pay in Full
If cash flow issues prevent full payment, take these steps:
Request a Short-Term Extension: For amounts under $100,000, you can request up to 120 additional days to pay through the IRS website.
Apply for an Installment Agreement: Form 9465 lets you request a monthly payment plan. The application fee ranges from $31 to $225, depending on your income and payment method.
Request Penalty Abatement: First-time penalty abatement may be available if you have a clean compliance history for the previous three years. Call the IRS or submit a written request explaining your situation.
Communicate Proactively: Never ignore IRS notices. Responding promptly and maintaining communication can prevent escalation to liens or levies.
How to Stay Compliant Year-Round
Maintaining good tax practices throughout the year helps avoid problems:
Monthly Reconciliations: Reconcile your point-of-sale system with inventory and cash records monthly to catch discrepancies early.
Dual-Control Cash Handling: Implement procedures requiring two people to verify cash counts and deposits, reducing errors and deterring theft.
Digital Record-Keeping: Use secure, cannabis-specific software to maintain detailed records of all transactions, inventory movements, and expenses.
Quarterly Internal Audits: Review your tax positions quarterly to ensure you’re tracking COGS properly and maintaining documentation for all transactions.
Work with Cannabis-Specialized Professionals: Partner with accountants and payroll providers who understand the unique challenges of cannabis businesses.Â
The Bottom Line
Federal taxation remains one of the biggest challenges for cannabis dispensaries. While Section 280E creates an uneven playing field, understanding the rules and implementing strategic approaches can help your business remain profitable despite the tax burden.
Focus on maximizing legitimate COGS deductions, maintaining meticulous records, and using secure, IRS-approved payment channels. File accurately, pay on time, and document everything. With proper planning and expert guidance, your dispensary can navigate federal tax obligations while positioning itself for long-term success.
FAQs On How Do Dispensaries Pay Federal Taxes
Can dispensaries deduct payroll expenses from federal taxes?
Generally no. Under Section 280E, employee salaries and wages are not deductible unless the employees directly participate in production or manufacturing activities that qualify as Cost of Goods Sold. Retail staff, management, and administrative personnel salaries typically cannot be deducted.
What happens if a dispensary doesn’t file Form 8300 for cash transactions?
Failing to file Form 8300 for cash transactions over $10,000 can result in penalties starting at $250 per form and increasing to $25,000 for intentional disregard. Criminal penalties can include fines up to $250,000 and imprisonment up to five years.
Can dispensaries use business tax credits?
Most business tax credits are unavailable to cannabis businesses due to Section 280E. However, certain credits related to employment taxes may still be available since these are separate from income tax deductions.
How long should dispensaries keep tax records?
Cannabis businesses should keep all tax records for at least seven years, though many experts recommend maintaining records indefinitely due to the higher audit risk in the industry. Digital backup systems are essential for preserving these records securely.
Can dispensaries deduct state cannabis taxes on their federal returns?
State-imposed cannabis excise taxes paid by the dispensary are generally considered part of COGS and can be deducted on federal returns. However, sales taxes collected from customers and remitted to the state are not deductible.
