ESOPs for Cannabis Operators: A Fix for the 280E Problem?

Section 280E has long been a financial detriment to cannabis companies. Now, with the Nov. 12, 2025, funding bill reversing the 2018 Farm Bill and criminalizing the sale of hemp-based products, hemp operators may also face the burden of Section 280E. While various tax strategies can soften its impact, one ownership structure can effectively neutralize Section 280E: the Employee Stock Ownership Plan (ESOP).

What is Section 280E?

Section 280E of the Internal Revenue Code prevents taxpayers from claiming deductions for expenses related to carrying on a trade or business that involves trafficking Schedule I or II substances under the Controlled Substances Act (CSA). Hemp operators may be less familiar with this rule, but cannabis companies know it well. Despite litigation challenging Section 280E and the CSA,[1] the provision remains in force, but novel arguments are emerging.[2]

Cannabis companies operate legally for state purposes, pay federal income taxes, and the federal government largely declines to enforce federal cannabis prohibitions against them. Yet they still cannot deduct ordinary and necessary business expenses under Section 162. At the same time, they are allowed to deduct their cost of goods sold (COGS).[3] However, wages, marketing, and administrative expenses are generally nondeductible. This creates a harsh reality for profitable or soon-to-be profitable companies.

What Are ESOPs?

Taxpayers have tried to mitigate Section 280E by restructuring operations or taking aggressive filing positions, but those approaches are risky from an IRS perspective. A more effective option is to convert ownership to an ESOP.

An ESOP is a qualified retirement plan designed to invest primarily in employer securities. A company creates an employee-sponsored trust and contributes new shares of its stock to the ESOP, or borrows funds to buy existing shares and contributes those shares to the plan. The ESOP then owns a portion or all of the company for the benefit of employees, who are allocated shares based on compensation and other plan terms. Historically, ESOPs have been used as a succession or liquidity tool for business owners. Cannabis operators are now using them for tax benefits.

Benefits of ESOPs to Cannabis Companies

ESOPs can be structured in various ways, but they offer two major potential benefits to cannabis companies.

1.     Neutralizing Section 280E

In a non-leveraged ESOP, company contributions to the ESOP to buy shares are tax-deductible. In a leveraged ESOP, the company makes tax-deductible contributions so the ESOP can repay acquisition debt. The key benefit for cannabis operators is that ESOPs do not pay federal income tax on their proportionate share of S-corporation income.

Consider a profitable hemp company taxed as an S-corporation and owned 100% by an ESOP. Because S-corporations are pass-through entities, all income and gains flow through to the shareholders. But the ESOP itself is tax-exempt. As a result, the hemp company would not pay federal income tax, eliminating the practical effect of Section 280E. Where the ESOP owns less than 100% of the company, the benefit scales with the ESOP’s ownership percentage.

2.     Providing Capital and Liquidity

ESOPs can help fund growth. A cannabis company that needs capital to build a facility or expand operations might struggle to obtain traditional bank financing or attract investors. In an ESOP transaction, the ESOP can borrow funds from a lender, and the business owner can sell shares to the ESOP at fair market value in exchange for cash. That cash can then be used to fund the expansion, while the company repays the ESOP loan over time with tax-deductible contributions. This allows owners to inject capital into the business without bringing in outside equity investors and without relying solely on reluctant financial institutions.

Benefits of ESOPs to Business Owners

Beyond company-level tax savings, ESOPs offer benefits to owners of cannabis operators. ESOPs provide a ready market for their shares and can facilitate a partial or complete exit. Instead of selling to a third party on the private market, an owner can sell shares at fair market value to an ESOP and, if desired, retain a meaningful stake and some operational control. The ESOP trustee will vote the ESOP-owned shares, while the owner continues to control their remaining interests. Stronger employee engagement and productivity are also common when employees become beneficial owners

Benefits of ESOPs to Employees

For employees, the primary benefit is the opportunity to accumulate equity in the company at no out-of-pocket cost, typically realized when they retire or leave the company. ESOP accounts grow tax-deferred, and distributions are generally taxed when received. In some cases, employees may roll proceeds into other qualified plans or IRAs to continue deferring tax.

Downsides and Considerations for ESOPs

Despite their advantages, ESOPs are not simple or universally suitable for cannabis or hemp companies.

First, the ESOP trust needs its own governance structure. Because the trust is a shareholder with voting rights, it requires a trustee or fiduciary decision-maker, usually appointed by the company’s board of directors.

Second, any sale of shares to the ESOP must occur at fair market value, supported by an independent appraisal. This valuation process is ongoing and often annual. Timing the transition is critical: Owners will want to maximize value, but the company must also have sufficient cash flow to service any ESOP-related debt. Further, a leveraged transaction may initially depress the company’s appraised value.

Third, ESOPs must comply with complex IRS and Department of Labor regulations. They are subject to retirement plan rules under IRC sections 401(a), 409, and 4975, among others. Regulators closely scrutinize ESOPs to ensure they operate in the best interest of employee participants rather than primarily benefiting former or current owners.

Conclusion

The rules for creating and operating ESOPs are intricate, and implementation requires experienced tax, legal, and valuation advisers. However, hemp companies soon to be subject to Section 280E should evaluate whether an ESOP structure could deliver tax savings, growth capital, and succession solutions that outweigh the added complexity.