Tax Credits for Cannabis Businesses: Maximizing Your Savings Potential

The cannabis industry is expanding rapidly as more states legalize medical and recreational use, but businesses face unique financial hurdles due to conflicting federal laws. Because the Controlled Substances Act classifies as a Schedule 1 drug, companies are barred from standard tax deductions under IRS Section 280E—forcing them to strategically navigate federal and state tax codes to minimize their burden and maximize savings.

Why Cannabis Businesses Overpay - And How to Fix It

The legal cannabis industry is booming, with U.S. sales projected to hit $71 billion by 2030. Yet, thanks to an outdated federal tax code, many businesses pay 2-3x more in taxes than traditional companies.

The culprit? IRS Section 280E, which prohibits standard business deductions for "trafficking" Schedule I substances—including state-legal cannabis. But savvy operators are fighting back by leveraging overlooked credits, COGS strategies, and state incentives. Here’s how to slash your tax bill legally.

1. Section 280E: The $1 Million Problem

Under 280E, cannabis businesses can’t deduct rent, payroll, or marketing—only Cost of Goods Sold (COGS).

Workaround:

• Maximize COGS by including:

  • Direct cultivation costs (seeds, labor, utilities for grow rooms)

  • Packaging directly tied to product (e.g., child-resistant containers)

• Separate business lines (e.g., a consulting arm) to deduct non-plant-touching expenses.

2. The Hidden Gem: R&D Tax Credits

Many cannabis companies qualify for the R&D Tax Credit (up to $250K/year) but don’t claim it.

Eligible activities include:

• Developing new strains or extraction methods

• Improving yield efficiency or THC/CBD consistency

• Quality control ie. product safety, or shelf-life innovations

Pro Tip: Even failed research counts. Document processes meticulously to support claims.

3. State-Level Savings (Where 280E Doesn’t Apply)

Some states decouple from 280E or offer cannabis-specific tax breaks:

• California: 15% credit for equity license holders.

• Oklahoma: Reduced effective tax rates for medical growers.

• Michigan: Allows standard business deductions on state returns.

Action Item: Check if your state offers:

• Tax holidays for new businesses

• Energy credits for sustainable grows

• Employment incentives for hiring locally

4. Audit-Proof Your Business

Cannabis is a high-risk industry for IRS audits. Protect yourself by:

• Tracking COGS in detail (use inventory management software like Flowhub or METRC).

• Avoiding red flags, like claiming 90% of expenses as COGS.

• Hiring a cannabis-specialized CPA (they’ll spot potential deductions you miss).

5. The Future: Will 280E Reform Happen?

Bills like the SAFE Banking Act could ease restrictions, but don’t wait. Act now:

1. Conduct a tax health check to identify missed credits.

2. Restructure operations to isolate deductible expenses.

3. Plan for 2026—R&D credits can be amended for prior years.

Understanding the Tax Code

• The Internal Revenue Code, specifically Section 280E, prohibits businesses from deducting expenses related to the trafficking of controlled substances, including cannabis, unless they are directly related to the cost of goods sold.

• Businesses in the cannabis industry must understand the tax code (and its implications) to benefit from available tax credits and deductions, such as the Research and Development tax credit.

• The tax code is complex, and cannabis companies must work with experienced tax professionals to ensure compliance and maximize savings.

Cost of Goods Sold and Tax Deductions

• The cost of goods sold (COGS) is a critical component of taxable income for cannabis businesses and includes direct costs such as raw materials, labor, and overhead.

• Cannabis companies can deduct COGS from their gross income, reducing their tax liability, but must carefully track and document these expenses to ensure compliance with federal and state tax laws.

• Other business expenses, such as advertising and rent, are not deductible under Section 280E, unless they are directly related to the cannabis production and sale of cannabis products.

Federal Implications

• Cannabis retailers are subject to federal laws that other businesses are not, including the payment of federal taxes on their gross income, and must navigate the complexities of federal taxation to minimize their tax burden.

• The federal government has not updated its laws to reflect the growing legal cannabis industry, leaving cannabis companies to operate in a gray area.

• Cannabis companies must be aware of the federal tax implications of their business activities, including the potential for audits and penalties.

Planning for Small Businesses

• Small businesses face unique challenges in terms of planning, including limited resources and expertise, and must prioritize tax planning to minimize their tax burden and maximize savings.

• Tax planning strategies for small marijuana businesses include accurate record-keeping, careful tracking of expenses, and taking advantage of available tax credits and deductions.

• Small businesses must also be aware of the potential for audits and penalties, and work with experienced tax professionals to ensure compliance.

Goods Sold and Inventory Management

• Cannabis businesses must carefully manage their inventory and track their COGS to ensure accurate tax reporting and minimize their tax liability.

• Inventory management is critical for cannabis companies, as it directly impacts their taxable income and ability to deduct expenses.

• Cannabis businesses must also be aware of the potential for inventory losses and theft, and have procedures in place to mitigate these risks.

Research and Development Tax Credits

• The Research and Development (R&D) tax credit is a valuable incentive for marijuana businesses, allowing them to deduct qualified research expenses from their taxable income.

• Companies can claim the R&D tax credit for activities such as developing new cannabis strains, improving cultivation techniques, and creating new products.

• The R&D tax credit can provide a significant tax savings opportunity for cannabis businesses, and companies should work with experienced tax professionals to ensure they are taking advantage of this incentive.

Navigating Audits and Compliance

• Cannabis businesses are at risk of audits and penalties due to the complexities of federal and state tax laws, and must prioritize compliance to minimize this risk.

• Cannabis companies must maintain accurate records, track expenses carefully, and work with experienced tax professionals to ensure compliance with federal and state tax laws.

• Audits can be time-consuming and costly, and cannabis businesses must be prepared to respond to audit requests and defend their assessments.

State and Local Considerations

• State and local laws can vary significantly, and cannabis businesses must be aware of the laws in their jurisdiction to minimize their levy load.

• Many states offer tax incentives and credits for cannabis businesses, such as the Agriculture Improvement Act, which can provide a significant savings opportunity.

• Cannabis companies must work with RedBud advisors to ensure they benefit from available state, local and federal tax incentives and credits.

Cannabis Business Operations and Taxation

• Cannabis business operations are subject to unique tax considerations, including the payment of federal taxes on gross income and the potential for audits and penalties.

• Cannabis companies must prioritize tax planning and compliance to maximize savings.

• Cannabis businesses must also be aware of the potential for changes in federal and state laws, and work with the RedBud professionals to stay up-to-date on the latest developments.

Cannabis taxation is brutal but not unbeatable. By aggressively pursuing COGS allocations, R&D credits, and state breaks, you can reclaim thousands—or millions—in lost savings.

Need help? Book a free consultation with the RedBud team to audit your savings potential.