Cannabis Business Tax Problems (IRC §280E)

Why state-legal cannabis businesses still face crushing federal tax bills, what changed with Schedule III rescheduling in 2026, and how Mike Habib, EA — a Whittier, California tax representation firm — defends cannabis operators against IRS audits and collection action.

Running a cannabis business legally under California state law does not mean the IRS treats you like any other business. It means, under a forty-year-old provision buried in the tax code, that most of your ordinary business expenses — rent, wages for non-production staff, marketing, insurance, even the interest on your business loan — cannot be deducted on your federal return at all. The provision is Internal Revenue Code section 280E, and it is the single biggest reason licensed, tax-paying, compliant cannabis operators routinely face federal effective tax rates of 60%, 70%, or higher, on businesses that would owe a fraction of that if they sold literally any other product.

This is not a hypothetical concern or an edge case. It is the defining tax reality of the legal cannabis industry, and it is why cannabis businesses are audited by the IRS at rates far exceeding the general small business population, and why so many otherwise successful, well-run dispensaries, cultivators, and manufacturers end up facing tax bills that threaten to shut them down entirely. Understanding exactly how §280E works — what it disallows, what it still allows, and how the rules changed in 2026 — is not optional knowledge for a cannabis operator. It is survival information, and the businesses that treat it that way from their very first year of operation consistently fare better under audit than the ones that discover the details only after an examination has already begun.

This guide walks through what §280E actually says, why it applies even to fully state-licensed businesses, what recent federal rescheduling action has and has not changed, how the IRS actually audits cannabis businesses, what the realistic penalty exposure looks like, and how Mike Habib, EA — a Whittier, California based tax representation practice — helps cannabis operators navigate this uniquely difficult corner of the tax code. Every code section, dollar figure, tax rate, and regulatory date in this guide has been verified against primary government sources before being written down.

Part One: What §280E Actually Says and Why It Exists

What Is the Actual Text of the Law?

Internal Revenue Code section 280E reads, in its entirety: “No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

Read that carefully, because the precision matters. The statute disallows deductions and credits — not gross income, not cost of goods sold, and not the business itself. It applies to any trade or business trafficking in a Schedule I or Schedule II controlled substance. And critically, it applies whether that trafficking violates federal law or state law — meaning a state cannabis license does not create an exception. It changes nothing about whether §280E applies, because the statute’s own terms track federal scheduling, not state legality.

Why Does This Law Even Exist?

Section 280E was enacted by Congress in 1982, added to the tax code by the Tax Equity and Fiscal Responsibility Act of that year (Public Law 97-248), specifically in response to a 1981 Tax Court decision that had allowed a taxpayer to deduct ordinary business expenses connected to an illegal drug-trafficking operation. Congress’s reaction was direct: it decided that whatever general principle allows businesses to deduct ordinary and necessary expenses should not extend to businesses built around trafficking in federally controlled substances, as a matter of clearly defined public policy. The law was never written with state-legal medical or recreational cannabis in mind — the entire industry as it exists today came into being more than a decade after §280E was already on the books — but because cannabis remained (and largely still remains) classified as a Schedule I controlled substance under the Controlled Substances Act, the cannabis industry became §280E’s primary modern application almost by accident of timing.

Does §280E Really Apply Even to a Fully Licensed, State-Compliant Dispensary?

Yes, and this is the single most important thing for any cannabis operator to internalize. The Tax Court has repeatedly and consistently confirmed that §280E applies to state-licensed medical and recreational cannabis businesses precisely because cannabis remains classified as a Schedule I substance under federal law, regardless of the fact that the business is operating legally, transparently, and in full compliance with state licensing and regulatory requirements. Unlike many other provisions of the tax code, §280E contains no exception tied to the level of federal enforcement or to whether a business is otherwise following every rule the state has laid down. A dispensary that pays every state tax on time, passes every state compliance inspection, and has never had a single legal issue with state regulators is treated exactly the same under §280E as it would be if it had none of those things — because the statute’s trigger is the Controlled Substances Act classification, not state legal status.

Part Two: The One Real Escape Valve — Cost of Goods Sold

If §280E Disallows Deductions, How Does Any Cannabis Business Survive Financially?

This is the single most important technical concept in cannabis tax planning, and getting it right is the difference between a business that pays a painful but survivable tax bill and one that collapses under an unnecessarily bloated one. §280E disallows deductions and credits. It does not touch Cost of Goods Sold (COGS), because COGS is not technically a deduction at all — it is a reduction to gross receipts that occurs before gross income is ever calculated, governed by an entirely separate part of the tax code, Internal Revenue Code section 471 and the related uniform capitalization rules under section 263A.

This distinction has been upheld consistently by the Tax Court and confirmed directly by IRS Chief Counsel guidance: a cannabis business calculates its federal taxable income by taking gross receipts, subtracting COGS to arrive at gross income, and only then applying §280E to disallow everything else — meaning the business is effectively taxed on its gross profit margin, not its net profit after normal operating expenses. For a cannabis business, correctly and aggressively (but legally) maximizing what gets classified as COGS, rather than a disallowed operating expense, is the single highest-leverage tax strategy available under current law.

What Can Actually Go Into COGS for a Cannabis Business?

The IRS addressed this question directly in Chief Counsel Advice 201504011, issued January 23, 2015, which remains the controlling guidance on how §280E interacts with inventory costing rules. The IRS concluded that a cannabis business is entitled to compute COGS only under the rules of section 471 as those rules existed at the time §280E was enacted in 1982 — not under the broader, later-expanded uniform capitalization rules of section 263A, which the IRS held cannot be used to convert an otherwise nondeductible expense into a deductible one through capitalization. In the IRS’s own words from that guidance, section 263A functions purely as a timing provision — it “does not change the character of any expense from ‘nondeductible’ to ‘deductible’ or vice versa.”

What this means in practice differs significantly depending on whether the business is a reseller (a dispensary buying finished product) or a producer (a cultivator or manufacturer creating the product from raw inputs):

• Resellers — dispensaries, delivery services — are governed by Treasury Regulation section 1.471-3(b), and can generally include in COGS the invoice cost of the cannabis purchased, less any trade or other discounts, plus transportation and other necessary charges incurred in acquiring possession of the product. This is a narrower set of costs than a producer can capture, which is exactly why the industry commonly observes that retail-only cannabis businesses bear the heaviest relative §280E burden — they have the fewest categories of cost available to shield from disallowance.
• Producers — cultivators and manufacturers — are governed by Treasury Regulation sections 1.471-3(c) and 1.471-11, and can generally capitalize a considerably broader set of costs into inventory: direct materials (seeds, clones, nutrients, growing media), direct labor directly tied to production (the wages of growers, trimmers, and production-line staff), and specific indirect production costs defined under the regulations, such as utilities, rent, and depreciation attributable to the production space itself, repairs to production equipment, and quality control tied directly to the manufacturing process.

This is precisely why the IRS’s own internal audit guidance for cannabis examinations instructs revenue agents that COGS methodology deserves intense scrutiny — because it is the primary lever cannabis businesses actually have, and it is also the primary place where aggressive or poorly documented positions collapse under audit.

What Happened in the CHAMP Case, and Why Does Every Cannabis Tax Discussion Mention It?

Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner — universally referred to in the industry as the “CHAMP” case — was decided by the Tax Court in 2007 and remains the foundational precedent for a strategy still used across the industry today: separating a single business into multiple, legally distinct activities, where only the activity that actually consists of trafficking in cannabis is subject to §280E.

In CHAMP, the taxpayer operated a medical cannabis dispensary that also provided a substantial range of caregiving services — counseling, support groups, and other non-cannabis wellness services — to its members. The Tax Court held that the government properly conceded that §280E did not disallow the deductions attributable to the taxpayer’s separate, lawful caregiving business, even though the same organization also sold cannabis, because the Court found the caregiving services constituted a genuinely separate trade or business from the cannabis trafficking activity.

The lesson from CHAMP is not that a business can simply relabel cannabis-related expenses under a different business name and escape §280E — later Tax Court decisions, including San Jose Wellness v. Commissioner in 2021, have made clear that this strategy only works where there is a genuine, substantively separate business with its own real operations, its own real revenue, and clear separation from the cannabis trafficking activity. A dispensary that also sells a handful of branded t-shirts and calls that a “separate retail business” will not survive audit scrutiny. A dispensary that operates a legitimately distinct, separately managed, and separately documented ancillary business — a genuine consulting practice, a real estate holding structure, a management company providing services to unrelated third parties as well as the cannabis operation — has a defensible position, but only with careful structuring and rigorous, contemporaneous documentation from day one. In San Jose Wellness, the Tax Court went further than CHAMP in the government’s favor, denying the taxpayer’s attempt to deduct depreciation and charitable contributions by finding that the dispensary’s activities, taken as a whole, constituted a single trade or business consisting of cannabis trafficking — reinforcing that the separate-business strategy demands genuine factual separation, not merely a different label applied to what is functionally the same operation.

Part Three: Rescheduling — What Actually Changed in 2026, and What Did Not

Did Marijuana Get Rescheduled in 2026? What Does That Mean for §280E?

Partially, and the distinction matters enormously for anyone trying to understand their own tax exposure right now. On April 23, 2026, following a December 2025 executive order directing an expedited process, the Acting Attorney General issued a final order immediately moving two specific, narrow categories of marijuana from Schedule I to Schedule III of the Controlled Substances Act, effective April 28, 2026: (1) FDA-approved drug products containing marijuana, and (2) marijuana products covered by a qualifying state-issued medical marijuana license.

Because §280E only applies to trafficking in Schedule I or Schedule II controlled substances, moving these two categories to Schedule III means §280E, by its own statutory terms, no longer applies to state-licensed medical marijuana operations that fall within this order — a genuinely significant development for the specific licensees it covers. The order also encouraged (though did not mandate) the Treasury Department to consider providing retrospective relief for §280E liability from years when a state licensee operated under a qualifying medical marijuana license before this order took effect. Critically, the order itself explicitly states that it does not constitute a determination of federal tax liability, and licensees are specifically advised to consult tax counsel rather than assume automatic relief applies.

What About Recreational, Adult-Use Cannabis Businesses — Did Anything Change for Them?

No. This is the point most likely to cause confusion, and it needs to be stated plainly: the April 2026 order covers only FDA-approved products and marijuana operating under a qualifying state medical marijuana license. Adult-use, recreational cannabis — including sales in states like California’s broader adult-use market — remains classified as Schedule I, and §280E continues to apply to those operations in full force, exactly as it did before April 2026. A dual-licensed California operator selling both to medical patients and to the general adult-use market may now find themselves in the unusual position of needing to track and separately account for §280E exposure that applies to one line of their business but not the other — an entirely new layer of complexity that essentially did not exist before this year.

Is Broader Rescheduling — Covering All Cannabis, Including Adult-Use — Coming?

It remains genuinely undecided as of this writing. The same April 2026 order simultaneously initiated an expedited DEA administrative hearing process to evaluate whether marijuana should be rescheduled more broadly — covering all forms, including adult-use and bulk cultivation, not just the two narrow categories already moved. That hearing formally opened June 29, 2026, before a DEA administrative law judge, and concluded July 15, 2026, after eleven days of testimony from designated participants on both sides. Post-hearing briefs from the parties were due by mid-August 2026. As of the most recent public information, no recommendation from the administrative law judge and no final agency decision has yet been issued. This means, for any cannabis business outside the narrow medical-license category already addressed, §280E remains fully in effect today, and any broader relief remains genuinely uncertain in both timing and ultimate outcome — a business planning its 2026 or 2027 tax position should not assume broader rescheduling will arrive on any particular timeline, or at all.

If I Hold a Qualifying State Medical Marijuana License, Do I Need to Do Anything Right Now?

Yes — this is exactly the kind of situation where getting professional guidance immediately, rather than waiting, has real financial consequences. Whether a specific license actually qualifies under the April 2026 order’s definition of a “qualifying state-issued medical marijuana license” is a fact-specific determination that depends on the precise licensing category, state program structure, and how a business’s operations map onto the order’s language — this is not something to assume based on a general sense that “we have a medical license.” Businesses in this position should have their specific licensing structure reviewed against the order’s actual requirements before changing how they file, and should not assume retroactive relief for prior years is automatic simply because the order encouraged Treasury to consider it — encouragement is not the same as a binding rule, and no formal Treasury guidance implementing retroactive relief had been issued as of this writing. Businesses that operate under both a medical license and a separate adult-use license in the same state face an even more layered question, since the order’s relief applies specifically to the medical-licensed activity and does not extend to adult-use sales conducted under a different license, even if both operations run out of the same facility.

Part Four: How the IRS Actually Audits a Cannabis Business

Why Are Cannabis Businesses Audited So Much More Often Than Other Small Businesses?

The IRS has developed and uses an internal examination guide specifically for the marijuana industry, and cannabis businesses face audit rates dramatically higher than the general small business population — a direct result of §280E creating an unusually high-stakes, high-dollar dispute on nearly every cannabis return filed. The IRS’s own internal guidance instructs examining agents that COGS methodology deserves particularly intense scrutiny, explicitly noting that because COGS is one of the only paths cannabis businesses have to reduce their federal tax burden, agents should expect — and look closely for — aggressive positions that attempt to shift what are really disallowed operating expenses into inventory costs where they do not belong.

The audit & examination guide also directs agents toward indirect methods of reconstructing income when a business’s books do not clearly reflect actual activity — a provision in the tax code that allows the IRS to bypass a taxpayer’s stated figures entirely and reconstruct income and expenses through other means when the taxpayer’s own accounting method does not clearly reflect income. For cash-intensive cannabis businesses, this commonly includes analyzing utility bills (particularly electricity usage for indoor cultivation, which correlates closely with plant count and yield), examining bank deposit patterns against reported cash expenditures, and comparing point-of-sale and seed-to-sale tracking system data (which nearly every state requires licensed operators to maintain) against what was actually reported on the federal return.

What Does an Effective Federal Tax Rate Actually Look Like for a §280E Business?

This is where the abstract legal concept becomes a concrete, often shocking, financial reality. A cannabis retailer with a healthy 50% gross margin — meaning COGS consumes half of gross receipts — still has to pay federal tax on its entire remaining gross profit, with essentially no deduction for rent, marketing, most wages, insurance, professional fees, or loan interest. Depending on the specific mix of allowable COGS versus disallowed operating expenses, effective federal tax rates for retail-heavy cannabis operations commonly run in the 40% to 70%+ range on what would, for any other retail business, be a modest or even negative net income after normal operating costs are properly deducted. Cultivators and manufacturers, who can capture a broader range of production costs into COGS under the regulations described earlier, generally fare somewhat better than pure retailers — but “somewhat better” in this context still frequently means effective rates well above what any conventional business in the same revenue range would ever face, and well above what the business’s own internally prepared profit and loss statement might lead an owner to expect before the federal return is actually filed.

What Is Form 8300, and Why Does It Matter So Much for Cannabis Businesses Specifically?

Because federal banking regulations have historically made it difficult or impossible for many cannabis businesses to access traditional banking relationships, the industry remains unusually cash-intensive compared to most other retail sectors. This makes Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, an unusually important and unusually risky compliance obligation for cannabis operators specifically.

Under the governing rule, any business receiving more than $10,000 in cash in a single transaction, or in two or more related transactions, must file Form 8300 within 15 days of receiving the cash. This includes situations where multiple smaller cash payments, made within a 24-hour window or as part of a series of related payments over a 12-month period, together exceed the $10,000 threshold — a business does not escape the requirement just because no single payment individually crossed the line.

The penalties for getting this wrong are genuinely severe. Civil penalties for a simple failure to file on time generally start at $100 per occurrence and can scale up substantially, but if the failure to file is found to be an intentional or willful disregard of the reporting requirement, a minimum civil penalty of $25,000 applies. Criminal penalties for willful violations can reach $25,000 to $500,000, depending on the specific violation and entity type, with potential imprisonment for the most serious cases. California layers an additional state-level requirement on top of the federal one: businesses filing Form 8300 with the IRS must also submit a duplicate to the California Department of Tax and Fee Administration within the same 15-day window. A cannabis business handling large cash volumes without a disciplined, systematic Form 8300 compliance process is sitting on a significant, entirely separate penalty exposure that has nothing to do with §280E or income tax at all.

What About California’s Own Cannabis-Specific State Taxes — Do Those Create Separate Audit Risk?

Yes, and this layer of exposure runs entirely independently of the federal §280E problem. California imposes a cannabis excise tax on retail sales, currently set at 15% of gross receipts as of October 1, 2025 (this rate briefly rose to 19% for the third quarter of 2025 before legislation — Assembly Bill 564, signed September 2025 — restored the 15% rate and delayed the next scheduled adjustment until fiscal year 2028-2029). This excise tax is collected by the retailer at the point of sale and remitted to the California Department of Tax and Fee Administration, and it sits on top of the standard statewide sales and use tax (a base rate of 7.25%, plus any applicable district add-ons), plus whatever local cannabis business tax the specific city or county imposes — commonly ranging from 2% to as much as 10% of gross receipts depending on the jurisdiction. The CDTFA conducts its own separate audits of cannabis excise tax compliance, entirely apart from anything the IRS is doing, and a cannabis business found to have miscalculated or underremitted state excise tax faces its own California-specific penalty and interest structure, on top of — not instead of — whatever federal exposure exists under §280E.

Part Seven: Banking, Payroll, and the Problems That Compound §280E

Why Does Cash Intensity Create Tax Problems Beyond Just Form 8300?

Federal banking regulators have historically treated cannabis-related deposits as connected to proceeds of a federally illegal activity, which has made many traditional banks and card processors unwilling to serve cannabis businesses directly, or willing to do so only through specialized, higher-cost banking relationships. This has pushed a meaningful share of the industry toward cash-heavy operations, and cash-heavy businesses create a very specific kind of audit exposure that goes beyond §280E itself: when there is no clean paper trail of deposits matching point-of-sale records, an IRS examiner has an easier time justifying the use of indirect income reconstruction methods described earlier in this guide — methods that tend to produce higher proposed income figures than a business’s own books would show, precisely because they rely on external proxies like utility usage or estimated markup rather than the business’s actual, if imperfectly banked, transaction records.

A cannabis business that has secured a stable, compliant banking relationship — even a specialized cannabis-focused one, and even if it comes with higher fees than a conventional business account — is in a meaningfully stronger position heading into any IRS examination than one still operating primarily on cash, simply because clean bank records make it dramatically easier to substantiate reported income and defend a COGS position with the kind of documentation an examiner actually wants to see.

Does §280E Affect Payroll Tax Withholding and the Trust Fund Recovery Penalty?

This is a distinction that catches many cannabis operators off guard, and it is important to be precise about it. §280E disallows income tax deductions for most operating expenses — it does not eliminate a cannabis business’s obligation to withhold, deposit, and remit federal payroll taxes on employee wages, and it does not change how the Trust Fund Recovery Penalty under Internal Revenue Code section 6672 applies if those payroll obligations are not met. A cannabis business squeezed by an unexpectedly large §280E-driven income tax bill sometimes makes the costly mistake of falling behind on payroll tax deposits to preserve cash for the income tax liability — and payroll tax debt is, in general IRS collection practice, treated far more aggressively than income tax debt, precisely because it involves money that was withheld from employees’ paychecks and held in trust for the government rather than money that was always the business’s own.

The Trust Fund Recovery Penalty allows the IRS to assess the unpaid trust fund portion of payroll tax personally against any individual determined to be a “responsible person” who willfully failed to ensure the taxes were paid — a determination that commonly reaches owners, and sometimes reaches managers or bookkeepers with meaningful control over which bills got paid. For a cannabis business already managing severe cash flow pressure from §280E, prioritizing payroll tax compliance over nearly every other obligation is not simply good practice — it is essential protection against a second, entirely separate, and personally reaching liability layered on top of the business’s existing federal income tax problem.

How Does §280E Interact With California’s State Income Tax Treatment of Cannabis Businesses?

California generally conforms to federal taxable income as the starting point for state income tax purposes, which means a cannabis business’s California income tax calculation typically begins from the same §280E-constrained federal taxable income figure, before any state-specific adjustments apply. This means the COGS methodology fight that plays out at the federal level has direct, dollar-for-dollar consequences at the state level as well — a favorable federal COGS position that survives an IRS audit generally carries through to reduce California income tax exposure too, and conversely, a federal adjustment that increases taxable income after an IRS audit typically has to be reported to the California Franchise Tax Board as a corresponding state adjustment, generally within six months under California Revenue and Taxation Code section 18622, triggering the same fight over the same numbers a second time at the state level if the business does not proactively address it.

Part Eight: Building the Right Entity and Recordkeeping Structure From the Start

What Should a Cannabis Business Set Up Before It Ever Gets Audited?

Given how heavily §280E audits turn on documented, contemporaneous cost allocation, the businesses that fare best under examination are consistently the ones that built the right systems before an examiner ever asked for anything — not the ones that scrambled to reconstruct records after receiving an information document request. This generally means: a chart of accounts specifically structured to separate COGS-eligible costs (production labor, direct materials, production-facility overhead) from disallowed operating expenses (retail floor costs, marketing, general administration) from the very first month of operations, rather than a generic small-business chart of accounts adapted after the fact; contemporaneous time tracking for any employee whose role spans both production and non-production activities, since labor that cannot be clearly allocated between the two tends to default toward the less favorable, fully disallowed treatment under audit; and square-footage documentation for any facility used for both production and retail or administrative purposes, established and dated at the time the space was configured, not estimated retroactively years later when an examiner asks for it.

What About Seed-To-Sale Tracking Data — Does That Help or Hurt in an Audit?

It generally helps, and business owners sometimes underappreciate this. Nearly every state cannabis licensing program, including California’s, requires licensees to maintain detailed seed-to-sale tracking through a state-mandated system, recording every plant, every harvest, and every unit of product from cultivation through final retail sale. This data — created for state regulatory compliance, not for federal tax purposes — often turns out to be some of the strongest, most contemporaneous, most difficult-to-dispute substantiation available for a federal COGS position, because it was generated in the ordinary course of state-mandated compliance rather than constructed after the fact for tax defense purposes. A cannabis business defending its COGS methodology that can tie specific production labor and material costs directly to specific seed-to-sale tracking records is in a substantially stronger position than one relying only on general ledger entries with no connection to the underlying regulatory tracking data the state already required it to keep.

Is It Ever Worth Paying More in Tax Now to Build a Cleaner Position for the Future?

Sometimes, yes — and this is a strategic conversation worth having deliberately rather than defaulting toward the most aggressive position available every year. A cannabis business considering an unusually aggressive COGS position that pushes right up against, or arguably past, the boundaries the IRS’s Chief Counsel guidance describes faces a real trade-off: a lower tax bill this year, against a substantially higher audit risk and potential penalty exposure if that position does not hold up under examination — and, because cannabis businesses are audited at elevated rates in the first place, that risk is not abstract. A somewhat more conservative position, properly documented and consistently applied year over year, sometimes produces a better overall outcome across a multi-year horizon than an aggressive position that saves money in year one but triggers an examination that unwinds three years of returns at once.

Part Five: Questions Cannabis Operators Actually Ask

Part Six: How These Cases Actually Play Out

Scenario 1: The Dispensary That Over-Claimed Deductions and Faced a Six-Figure Proposed Assessment

A licensed retail dispensary in Los Angeles County had, for three consecutive years, followed guidance from a bookkeeper unfamiliar with §280E and claimed standard business deductions for rent, marketing, and staff wages exactly as any other retail business would. An IRS examination proposed disallowing nearly all of these deductions, along with an accuracy-related penalty, resulting in a proposed additional assessment exceeding $180,000 across the three years combined.

Mike Habib reviewed the business’s actual operations and identified that a meaningful portion of the disallowed rent was attributable to a back-of-house area used for compliant packaging and labeling activities that, under the reseller COGS rules, could properly be treated as part of the cost of acquiring the product in saleable condition, rather than a purely retail-floor expense. Working with the business’s actual invoices, lease documentation, and square-footage records, Mike prepared a revised COGS calculation and a formal protest to the proposed assessment. The final resolution reduced the proposed liability by roughly 35%, and — because the position taken was well-documented and defensible rather than an aggressive overreach — the accuracy-related penalty was fully abated.

Scenario 2: The Cultivator With a Strong COGS Position Who Still Needed Representation

A licensed cultivation operation had, from its first year of licensure, worked with an accountant experienced in cannabis-specific inventory costing, correctly capitalizing direct materials, production labor, and production-facility overhead into COGS under the producer rules. Despite a technically sound approach, the business was selected for examination — cannabis businesses routinely are, given IRS audit priorities in this industry — and needed to substantiate every element of its COGS calculation with contemporaneous documentation.

Mike Habib organized and presented the complete substantiation package: production labor records tied to specific grow cycles, utility bills allocated between production and non-production space based on documented square footage and usage patterns, and depreciation schedules tied specifically to production equipment rather than general business assets. Because the underlying position was sound and the documentation was thorough, the examination closed with no change to the originally filed returns — a result that depended entirely on having organized, audit-ready substantiation available rather than reconstructing it under pressure after the examination began.

Scenario 3: The Form 8300 Compliance Gap That Created Separate, Unexpected Exposure

A cash-intensive dispensary had been filing Form 8300 inconsistently — filing for some large cash transactions but missing others, particularly situations involving multiple related cash payments from the same customer across several visits within a short period, which the aggregation rule requires to be treated as a single reportable transaction. An IRS review of the business’s cash handling identified a pattern of missed filings spanning roughly eighteen months.

Mike Habib worked with the business to reconstruct the actual transaction history from point-of-sale and seed-to-sale tracking records, identify every instance that should have triggered a Form 8300 filing, and prepare and file the delinquent forms along with a detailed explanation addressing why the failures reflected a genuine gap in the business’s internal process — recently identified and corrected — rather than an intentional disregard of the reporting requirement. This distinction mattered enormously to the outcome, because it kept the case within the lower civil penalty range for ordinary late filing rather than the $25,000-per-violation minimum that applies specifically to willful disregard.

Scenario 4: The Pre-Sale Due Diligence Review That Avoided an Escrow Holdback

The owners of a profitable, multi-year cultivation and manufacturing operation entered discussions to sell the business and, in preparing for buyer due diligence, engaged Mike Habib to independently review their historical COGS methodology before the buyer’s own accountants did. The review found that the business’s existing approach was generally sound but had inconsistently applied labor allocation between production and administrative staff across two of its five years of operation, creating a real, if moderate, exposure that an experienced buyer-side due diligence team would likely flag and use to justify a purchase price reduction or an escrow holdback pending resolution.

Mike Habib prepared amended returns correcting the inconsistent years before the transaction closed, along with a clear, organized memorandum documenting the business’s corrected and consistently applied methodology going forward. Because the issue was identified and resolved proactively, on the seller’s timeline, rather than discovered by the buyer’s team during live negotiations, the sale proceeded without the price reduction or extended escrow holdback that typically accompanies unresolved tax exposure discovered mid-transaction.

How Mike Habib, EA Approaches Cannabis Tax Cases

Start With an Honest, Technical Review of the COGS Position

Every cannabis tax engagement begins the same way: a careful, technically grounded review of how the business has been classifying its costs, measured against the actual rules under section 471 and the Chief Counsel guidance interpreting how §280E interacts with them — not against generic small-business bookkeeping assumptions that simply do not apply to this industry. This matters whether the business is currently under audit, anticipating one, or simply trying to get its ongoing tax position right for the first time. An honest review sometimes finds a position that is too conservative, leaving legitimate COGS on the table; other times it finds a position that is too aggressive and needs to be corrected before an examiner finds it first.

Build Documentation That Actually Survives an Examiner’s Scrutiny

Given how heavily the IRS’s own internal guidance instructs agents to scrutinize cannabis COGS methodology, the documentation standard for a cannabis business needs to be considerably higher than what a typical small business maintains. Mike Habib works to establish and organize the specific records that actually matter under audit — production labor tied to specific activities, square-footage allocations between production and non-production space, invoices and cost records that map clearly to the COGS categories the regulations actually allow — before an examination begins wherever possible, and as thoroughly as circumstances allow once one has.

Handle the IRS Directly, Including Appeals When a Proposed Adjustment Is Not Supportable

Where an IRS examiner proposes an adjustment that does not hold up against the actual facts and the governing regulations, Mike represents the business through the protest and appeals process, presenting the case to the IRS Independent Office of Appeals where warranted — a genuinely different, more receptive forum than the original examination, as described in earlier guides in this series covering audit and collection representation generally.

Why Flat-Fee Representation Fits Cannabis Cases

Cannabis tax cases often involve real, business-threatening dollar amounts precisely because of how §280E inflates effective tax rates. An hourly billing structure creates exactly the wrong dynamic for a business already facing a difficult cash position because of the very tax burden being disputed — the more complex the COGS reconstruction or the longer an examination runs, the larger the bill grows, right when the business can least afford it.

Mike Habib, EA represents cannabis tax cases at a flat fee, quoted once the scope of the review, reconstruction, or representation work is understood. You know the cost of getting this handled correctly before the work begins — no hourly meter running while COGS documentation gets organized, no surprise bill because an examination took longer than expected.

About Mike Habib, EA

Mike Habib is a federally licensed Enrolled Agent, which means he holds unlimited practice rights before the IRS and can represent taxpayers in audits, appeals, collections, and all IRS matters. He operates Mike Habib, EA, a tax representation and business financial advisory practice based in Whittier, in Los Angeles County, California, serving clients in all fifty states.

Before building the representation practice, Mike worked in corporate finance, including service as a Controller at Xerox Corporation and Director of Finance at AEG. That background is directly relevant to §280E defense work, which turns heavily on precise inventory costing, cost allocation between production and non-production activity, and the ability to present a business’s financial structure credibly and technically to an IRS examiner — exactly the kind of work Mike did for years before moving into tax representation.

He has more than 20 years of experience in tax representation. The practice holds professional memberships in the National Association of Enrolled Agents, the California Society of Enrolled Agents, and the National Association of Tax Professionals. Mike Habib, EA is a BBB A+ Accredited Business.

Every case is handled personally by Mike. There is no intake department, no junior staff the file gets handed to, and no one between you and the person who will actually be building your COGS defense, organizing your documentation, and responding to the IRS on your behalf.

What to Do Right Now

If your cannabis business is currently under IRS examination, the priority is making sure your COGS methodology is documented and defensible before you respond to a single information document request — a poorly prepared initial response can shape the entire trajectory of the examination and is difficult to walk back later. If you have not yet been audited but are unsure whether your current approach to §280E would survive scrutiny, a proactive review now, on your own timeline, is far less costly than the same review conducted under examination pressure later. If you hold a state medical marijuana license and believe the 2026 rescheduling order may apply to your operations, that determination needs a careful, fact-specific review rather than an assumption either way.

Call Mike Habib, EA at 562-204-6700 or 1-877-788-2937. Or ONLINE to set up a consultation. Bring your current cost accounting methodology, your entity structure, and any IRS correspondence you have already received.

A preliminary review of your COGS position and overall §280E exposure typically takes just a few days once your records are available. From there, you get a flat-fee quote for the specific work your business needs, whether that is audit representation, a proactive COGS review, entity and banking structure guidance, or planning around the still-evolving rescheduling landscape described earlier in this guide.

The problem will not be resolved by waiting, and it will not be improved by an aggressive position taken without documentation to support it. Section 280E is not going away for most of the industry anytime soon, and it does not forgive good intentions or state-law compliance. What it does respond to is a correctly built, well-documented, technically sound tax position — built by someone who understands exactly how the IRS actually examines these cases, and who is prepared to defend that position through examination and appeals if it comes to that.