Yes, the federal government’s oppressive tax structure under Internal Revenue Code Section 280E still applies to state-sanctioned cannabis businesses under the plant’s Schedule I control status, according to congressional researchers.
However, whether Section 280E violates the Eighth Amendment’s Excessive Fines Clause “is a matter of debate,” according to a Congressional Research Service (CRS) report published Feb. 6.
The report addresses tax-related legal issues for cannabis businesses on the heels of President Donald Trump’s executive order on Dec. 18, which directed U.S. Attorney General Pamela Bondi to expedite the process of reclassifying cannabis from a Schedule I to Schedule III drug under the Controlled Substances Act (CSA).
Neither Bondi nor the Department of Justice (DOJ) has provided a public update on that process – to loosen federal restrictions on cannabis – nearly two months later.
Until cannabis is reclassified to Schedule III or lower under federal law, Section 280E prevents state-sanctioned cannabis businesses from writing off many of their day-to-day expenses and overhead costs, including payroll, rent, utilities and even charitable gifts to promote goodwill, according to the CRS.
“Section 280E applies to marijuana businesses operating in compliance with state law because trafficking marijuana continues to violate federal law,” according to the report. “The federal government has not consistently enforced the CSA against state-sanctioned marijuana businesses. However, any lack of enforcement of the CSA does not render Section 280E inoperable.”
This means cannabis businesses, from cultivators and processors to distributors and retailers, remain on the tax hook until the Trump administration potentially finishes what President Joe Biden’s DOJ initiated – a proposed Schedule III rule in May 2024. Until then, many cannabis operators continue to face effective federal income tax rates that approach as high as 80%.
This 280E tax burden often represents the difference between profitability and unprofitability in the cannabis space. In 2024, Whitney Economics estimated that only 27.3% of U.S. cannabis operators were profitable. This compares to roughly 65% of all small businesses in the U.S. that are profitable.
The Eighth Amendment’s Excessive Fines Clause
As the federal government continues to treat cannabis businesses differently from other American businesses, congressional researchers evaluated the following question: Does Section 280E violate the Eighth Amendment’s Excessive Fines Clause?
To answer this question, the CRS weighed a 2019 case, Northern California Small Business Assistants Inc. v. Commissioner of Internal Revenue, in which the U.S. Tax Court ruled that Section 280E does not violate the Excessive Fines Clause. However, a panel of the court’s judges offered differing opinions.
“Whether Section 280E’s disallowance of deductions is a denial of a tax benefit or a punishment for the purposes of the Eighth Amendment is a matter of debate,” according to the CRS report, noting that the Supreme Court has ruled that a “fine is excessive” where it is “grossly disproportional to the gravity of [the] offense.”
In the 1998 Supreme Court case, United States v. Bajakajian, the court ruled that the “touchstone of the constitutional inquiry under the [Eighth Amendment’s] Excessive Fines Clause is the principle of proportionality: The amount of the forfeiture must bear some relationship to the gravity of the offense that it is designed to punish.”
So, is taxing cannabis businesses differently designed to punish their “offense” of a federal law that the federal government, specifically the DOJ, overwhelmingly does not enforce?
The Senate Finance Committee provided insights in a report that was attached to the 1982 legislation that enacted Section 280E:
“There is a sharply defined public policy against drug dealing. To allow drug dealers the benefit of business expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons is not compelled by the fact that such deductions are allowed to other, legal, enterprises. Such deductions must be disallowed on public policy grounds.”
That was 14 years before California became the first state to legalize medical cannabis in 1996. And times have certainly changed since then. With the majority of Americans now living in states with adult-use legalization, public policy has shifted: 64% of U.S. adults favor federal cannabis legalization in 2025, according to a Gallup survey.
Still, cannabis companies are treated differently.
In the 2019 U.S. Tax Court case, a medical cannabis dispensary in California argued that Section 280E imposes a gross receipts tax as a penalty in violation of the U.S. Constitution, after the IRS issued the company a notice that denied its attempt to take 280E tax deductions.
“At the heart of the taxpayer’s arguments was that Section 280E imposed a penalty in violation of the Eighth Amendment’s Excessive Fines Clause,” according to the CRS. “The panel agreed to deny the taxpayer’s motion for summary judgment, but the judges varied in their approach to reaching that decision.”
While 10 Tax Court judges were in the majority, holding that Section 280E does not violate the Excessive Fines Clause, three judges concluded that Section 280E imposes a fine but did not determine whether that fine was “excessive.”
“The opinion emphasized Congress’s unquestionable authority to tax gross income and concluded that Congress was the proper body to address the taxpayer’s grievances,” according to the report.
Although cannabis businesses cannot deduct their ordinary business expenses under Section 280E, the tax code does not prevent cannabis operators from reducing their gross receipts by the cost of goods sold (COGS) when calculating their federal income tax liability, because “COGS offsets gross receipts when determining gross income, whereas deductions reduce gross income to calculate taxable income,” according to the CRS.
Cannabis businesses can calculate their COGS by adding their start-of-year inventory to their year’s purchases and production costs, and then subtracting their year-end inventory.
“Outside this general convention, there is little tax guidance concerning the application of Section 280E,” according to the report. “Marijuana businesses have generally been unsuccessful in challenging the Internal Revenue Service’s (IRS’s) application of Section 280E and likewise have not succeeded in their attempts to challenge Section 280E on constitutional grounds.”
