Tax Issues Related to Marijuana Businesses

Many states have legalized marijuana for medical use and recreational purposes. At the federal level, marijuana is still an illegal narcotic. The Controlled Substances Act allows law enforcement to prosecute sellers. However, the IRS requires businesses to declare all income for tax purposes.

Legal marijuana businesses must pay sales tax, use tax, and excise taxes. The confusing relationship of federal, state, and local taxes can easily cut into the profit margin of marijuana business owners.

Understanding the state and federal tax laws is essential for anyone planning on owning or operating a cannabis business. In this article, we’ll explain the basics of business taxes in the cannabis industry.

Each state has its own set of laws surrounding the sale of cannabis, so it’s best to consult a local cannabis law attorney or a tax attorney before beginning your business plan.

Business Taxes and the Cannabis Business

Most cannabis companies are small businesses. Depending on their nature, small businesses can expect to pay taxes according to local and state tax codes. For example, food service businesses pay different taxes on hot, ready-to-eat food versus food eaten in the establishment.

In the case of cannabis businesses, states typically have separate code sections for cannabis, and may have sections for:

• Product types, such as flowers, buds, edibles, and seeds

• Business types, such as growers, distributors, or dispensaries

• Potency of product taxes, devised for states where THC content must be below a certain percentage

Business owners know how confusing tax laws are. They are especially complex for those trying to figure out tax obligations of their cannabis business, such as a grower or dispensary.

Tax implications vary depending on the different types of cannabis products sold, such as flowers or edibles. But cannabis is still a controlled substance according to federal law. This makes tax compliance even more confusing.

State and federal taxes apply when you start a business in a cannabis industry state that has legalized adult-use marijuana. State and federal taxes apply to your sales. It is also important to know possible tax credits and deductions that apply to your cannabis business.

Marijuana Business and Federal Taxes

Businesses deduct “ordinary, necessary, and reasonable” business expenses on their federal taxes. Tax deductions allow businesses to pay taxes on their net income rather than gross income by lowering their total profits. Businesses can take part of their operating expenses out of their taxable income before paying.

However, Section 280E of the Internal Revenue Code bans all deductions and tax credits for the illegal trafficking of drugs. The IRS still classifies marijuana businesses of all types as “illegal trafficking,” even if the businesses are legal under state law.

The agency has offered some guidance on deducting the cost of goods sold (COGS). COGS can still be deducted because it’s not technically a “deduction” under tax law – it’s used to calculate gross income. But in general, all income from a cannabis business is taxable.

This creates an unusually high tax burden compared to other businesses, making cannabis businesses pay taxes on revenue rather than profit in many cases.

To avoid an excessive tax burden, medical marijuana dispensaries sometimes use other methods of spreading the tax load. Things like an employee stock ownership plans (ESOPs) help make the profit tax deductible.

State Taxes on Marijuana

As of 2025, 40 states and the District of Columbia have legalized the use of medical marijuana. Twenty-four permit recreational use of various cannabis products. Eight states allow “low THC, high cannabidiol” products such as CBD oil. All 50 states allow some type of cannabis product, even if it is a 0.01% oil, like Idaho’s cannabis law.

All states with legal marijuana businesses have some form of state retail sales tax. The marijuana tax rate may match that of the state or local sales tax, or it may be a flat state tax.

For instance, California levies a flat 19% tax on all marijuana purchases. Colorado requires a separate tax license for medical and retail marijuana, even in the same establishment.

Tax evasion is a fast way for state and federal governments to force a company out of business. Failing to follow state and local regulations means a business can be closed indefinitely, even without criminal prosecution.

Get Legal Help With Your Marijuana Tax Questions

Federal marijuana law and enforcement fluctuate with the administration in office and national opinion. Federal agencies have generally deprioritized enforcement in compliant state-legal operations. But federal law still supersedes state law, so business owners should follow federal regulations closely. States can legalize marijuana and cannabis businesses, but local governments have the option to keep businesses out of their city limits.

Marijuana business owners and would-be entrepreneurs should consult an experienced cannabis business attorney who knows the state’s marijuana laws before attempting to open any business in the area. They can guide you through the process of setting up your business and ensure you stay on the IRS’s good side.