280E and Payroll: What Cannabis Employers Need to Understand
Section 280E is why a dispensary and a liquor store with identical economics can end up with wildly different federal tax bills. It is also the reason your time-tracking configuration is a tax matter and not merely an HR preference.
The landscape shifted in 2026, and a lot of Minnesota operators have concluded the problem went away. For most of them it did not.
What 280E does
Congress enacted Section 280E in 1982 to stop drug traffickers from deducting business expenses against illegal income. The text is short and makes no exception for state-legal operations: no deduction or credit is allowed for a trade or business that consists of trafficking in controlled substances listed on Schedule I or Schedule II.
Applied to a licensed cannabis business, that means rent, marketing, professional fees, and wages are not deductible at the federal level. Courts upheld it against cannabis businesses for more than a decade.
One relief valve has always existed. Cost of goods sold is not a deduction — it is a reduction of gross receipts in arriving at gross income. So COGS survives 280E, and cannabis businesses determine inventory costs under Section 471 as it existed when 280E was enacted. Section 263A cannot be used to push otherwise disallowed expenses into inventory.
That single distinction produced the structural asymmetry that has defined cannabis accounting: cultivators, who can capitalize a large share of production costs into inventory, fared meaningfully better than retailers, whose costs are overwhelmingly the selling and administrative expenses 280E disallows.
What changed in 2026, precisely
Read this section carefully, because the headline version is misleading.
In April 2026 the Department of Justice issued a final order moving certain marijuana products from Schedule I to Schedule III. The order covered two categories: marijuana in FDA-approved drug products, and marijuana subject to a qualifying state medical marijuana license.
Adult-use marijuana was not covered. Product outside those categories remains on Schedule I, and 280E continues to apply in full to that activity.
For the majority of Minnesota’s licensed operators, whose business is adult-use retail and the supply chain feeding it, this is the sentence that matters. The rescheduling that dominated industry news does not change your federal tax position.
Treasury and the IRS have indicated that rescheduling is expected to remove 280E for covered operators, and a transition rule has been anticipated for the year the final order takes effect. Formal guidance has been slower than the order itself. Anyone with covered activity should be working from their own tax advisor’s read of current guidance, not from a payroll company’s summary.
Three consequences that hold regardless:
- Prior years still run on the old rules. If a pre-2026 return is examined, it is evaluated against 280E as it stood, and the payroll records supporting those COGS allocations need to still exist.
- Mixed operations get harder, not easier. A business with both covered and non-covered activity has to allocate between them, which means overhead and payroll have to be attributable to one side or the other.
- Section 471 discipline still matters for any activity that remains on Schedule I.
Whatever else the transition did, it did not make documentation less important. It added a second axis to allocate along.
Why this lands on payroll
Labor is the largest cost most operators would like to capitalize. Whether they can depends entirely on what a given person actually did with their hours.
Broadly, and with the caveat that this is your tax advisor’s call and not ours:
- Cultivation and production can generally include direct production labor and certain production-related overhead in inventory cost. General administrative, marketing, and non-production expenses do not qualify.
- Retail and dispensary COGS is generally limited to the purchase price of inventory, inbound freight, and handling costs tied to getting inventory ready for sale. Payroll, rent, marketing, and administrative expenses do not belong there.
Which puts the weight on a question payroll answers or fails to answer: what did this employee do, and for how many hours?
A trim technician who spent 38 hours trimming and 2 hours restocking the retail floor is not the same tax fact as an employee coded to a single blended role for all 40 hours. If your time system produces one number per person per week, you do not have the record. You have a total.
What defensible payroll records look like
None of this is exotic. It is ordinary payroll hygiene applied with the knowledge that someone may read it years later.
- Hours by function, not just totals. Job codes or departments that map to the categories your tax advisor uses, captured at the time the work happens rather than reconstructed at year end.
- A written allocation method for split-role employees. Decide the method, write down the reasoning, and apply it consistently across quarters. Choosing an approach at filing time is the version that draws attention.
- Reconciliation. Payroll registers should tie to the general ledger and to filed employment tax returns. Any variance you cannot explain is a variance someone else will interpret.
- Entity discipline. Some operators are looking at separate legal entities for medical and adult-use activity. That can clarify allocation, and it carries licensing, transfer pricing, and formation consequences that need modeling before anyone reorganizes anything.
- Retention. Keep the records that support prior-year positions. Minnesota’s employment recordkeeping rules already require three years; your tax exposure window may be longer.
The operators in the strongest position have clean books, consistent inventory processes, and COGS supported by records that were built as the work happened.
What 280E does not touch
Worth saying, because the confusion is common and expensive.
280E is an income tax provision. It has nothing to do with your obligation to withhold and remit employment taxes. Federal income tax withholding, Social Security, Medicare, and federal unemployment tax are all owed and payable exactly as they are for any other employer. So are Minnesota withholding, unemployment insurance, and Paid Leave premiums.
It also has no bearing on wage and hour law. Minimum wage, overtime, earned sick and safe time, break requirements, and the wage theft notice and recordkeeping rules apply in full. A federal tax provision that limits your deductions does not reduce what you owe your employees or the state.
And note the direction of the incentive. 280E raises the after-tax cost of labor for non-covered operators, which creates pressure to classify workers as contractors or to leave hours off the books. Both are catastrophically bad trades. Misclassification penalties in Minnesota run to five figures per violation with personal liability for owners and officers, and unreported wages create exposure across payroll tax, workers’ compensation, and unemployment simultaneously.
The practical takeaway
Your tax advisor decides the position. Payroll produces the evidence. Those are different jobs, and the evidence has to exist before the position is taken.
Roll With Paid. runs payroll for cannabis operators across Minnesota with job coding, function-level time capture, and records that reconcile — so that when your CPA asks what a given employee actually did in Q2 of two years ago, the answer exists. We do not prepare tax returns or advise on 280E positions. We make sure the underlying records can support whatever position your advisor takes. Start here.
Related: five payroll mistakes cannabis businesses can’t afford, workers’ comp classification codes, and our Employer Resources page.
Frequently asked questions
What is Section 280E?
A 1982 Internal Revenue Code provision denying deductions and credits to a trade or business trafficking in Schedule I or Schedule II controlled substances, with no carve-out for state-legal operations. COGS survives it, because COGS reduces gross receipts rather than operating as a deduction.
Did the 2026 rescheduling end 280E?
Only for covered activity. The April 2026 final order moved FDA-approved marijuana drug products and state-licensed medical marijuana to Schedule III. Adult-use marijuana remains on Schedule I, and 280E still applies to it.
Why does 280E matter for payroll?
Because wages are the largest cost operators try to capitalize into COGS, and whether that is supportable depends on what each employee actually did. Time records and job coding become the evidence for a tax position.
Can retailers put payroll into COGS?
Generally not the way producers can. Retail COGS is typically limited to inventory cost, inbound freight, and handling to make inventory ready for sale.
What records support a COGS position?
Hours captured by function, job or department coding, a written and consistently applied allocation method for split roles, and payroll registers that reconcile to the general ledger and filed employment tax returns.
This article is not tax advice. Roll With Paid. is not a law firm or an accounting firm and does not provide legal or tax advice. Section 280E positions, COGS allocation methods, and the effect of rescheduling on any particular business are matters for a qualified tax professional who knows your facts. Federal guidance in this area was actively developing as of August 2026 and may have changed. Do not make a tax decision based on this article.