How Do Dispensaries Pay Federal Taxes?

Cannabis dispensaries exist in a unique financial landscape, operating under state laws that permit their existence while simultaneously being classified as illegal drug trafficking operations by the federal government. This conflict creates a complex federal tax situation. This legal paradox has long been shaped by the federal classification of cannabis as a Schedule I controlled substance.

However, this landscape is on the verge of a historic shift. In 2024, the U.S. Department of Justice initiated the formal process to reclassify cannabis to Schedule III. If finalized, this change would mean that certain restrictive tax rules would no longer apply to state-legal cannabis businesses, fundamentally altering their federal tax obligations.

The Impact of Federal Law on Taxable Income

The primary challenge for dispensaries stems from Internal Revenue Code (IRC) Section 280E. Enacted in 1982, this law was originally intended to prevent convicted illegal drug traffickers from claiming tax deductions for their business expenses. As long as cannabis remains a Schedule I substance at the federal level, Section 280E applies directly to state-legal cannabis businesses, treating them as “trafficking” operations for tax purposes.

The core provision of Section 280E is its prohibition on deducting otherwise ordinary and necessary business expenses from gross income. Common operating costs that are non-deductible include rent for the retail storefront, marketing and advertising, and the salaries of employees not directly involved in producing or acquiring inventory, such as budtenders, managers, and administrative staff. Other disallowed deductions include utilities, insurance premiums, and professional fees paid to lawyers or accountants.

This restriction means dispensaries are taxed on their gross profit, not their net profit, resulting in an effective tax rate that can soar to 70% or higher. To illustrate, consider a regular retail business and a cannabis dispensary that both have a gross profit of $400,000 from $1,000,000 in revenue. If both businesses also have $300,000 in operating expenses, the regular business would have a taxable income of $100,000. In contrast, the dispensary cannot deduct its operating expenses, so its taxable income remains $400,000, leading to a much higher tax bill.

Determining Cost of Goods Sold

While Section 280E is restrictive, it does permit dispensaries to subtract the Cost of Goods Sold (COGS) from their gross revenues. This makes the accurate calculation of COGS the single most important accounting task for a cannabis retailer. COGS refers to the direct costs associated with acquiring the products that are sold.

In the context of a cannabis retailer, includable COGS are primarily the wholesale price paid for cannabis products like flower, edibles, and concentrates. Transportation costs incurred to acquire these products from a cultivator or processor are also deductible as part of COGS. If the dispensary engages in any direct processing or packaging, the labor costs for those specific activities can be included. Conversely, operating expenses disallowed under Section 280E, such as rent for the retail facility and marketing materials, are explicitly excluded from COGS.

To properly calculate COGS, dispensaries must maintain detailed inventory records. Accounting methods such as First-In, First-Out (FIFO) or Last-In, First-Out (LIFO) are used to determine the value of the inventory that has been sold. The choice of method can have a significant impact on the COGS calculation and, consequently, the dispensary’s taxable income.

Methods for Submitting Federal Tax Payments

After calculating their tax liability, dispensaries face another significant hurdle: the physical act of paying the IRS. Because cannabis is federally illegal, most banks and financial institutions refuse to provide services to these businesses to avoid federal penalties. This lack of access to the banking system makes paying taxes via electronic funds transfer or a business check nearly impossible for many operators, forcing them to use alternative methods.

Common workarounds include:

• Making cash payments at an IRS Taxpayer Assistance Center (TAC). This process requires scheduling an appointment in advance and presents security risks, often forcing businesses to hire armored transport to deliver the funds.
• Using third-party payment processors. These services act as an intermediary, accepting cash from the dispensary and converting it into a digital payment for the IRS, but they charge fees for their services.
• Purchasing money orders or cashier’s checks. These instruments often have purchase limits, meaning a business might need to acquire multiple checks to cover a large tax liability, which can be impractical.
• Utilizing services like PayNearMe, which allow taxpayers to make cash payments at participating retail locations after generating a payment code on the IRS website.

Required Tax Filings and Documentation

Dispensaries must report their income using the same standard forms as any other business, but the data is shaped by Section 280E. The specific form used depends on the dispensary’s legal structure, such as Form 1120 for a C-Corporation or Schedule C on a personal Form 1040. On these forms, the line items for deductions like rent and advertising will be blank, with the only significant reduction to gross income being the carefully calculated COGS.

To withstand potential IRS scrutiny or an audit, a dispensary must have thorough records. This includes:

• All supplier invoices for cannabis products.
• Detailed inventory tracking records that support the chosen accounting method.
• Freight bills for transportation costs.
• Payroll records organized to clearly distinguish direct labor costs includable in COGS from administrative or retail salaries.

Any cash transaction exceeding $10,000 requires the business to file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, with the IRS within 15 days of the transaction. Proper documentation is a necessity for a business operating in such a high-risk tax environment.