Tax Planning for Ancillary Cannabis Businesses: How to Avoid the 280E Trap

If you sell consulting services, equipment, branding, technology, or real estate leases to cannabis operators, you are not in the same tax position as the operator itself. IRC 280E denies virtually all deductions to businesses that traffic in Schedule I or II controlled substances, but it does not reach businesses that merely serve the cannabis industry without touching the plant. That distinction is the single most valuable line in cannabis tax planning, and structuring around it correctly can mean the difference between a 70%+ effective tax rate and a normal one.

What does IRC 280E actually prohibit, and who does it hit?

IRC 280E is a one-sentence statute. It says that 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 that trade or business consists of trafficking in controlled substances prohibited by federal law. As of September 2026, marijuana remains a Schedule I controlled substance under the Controlled Substances Act. It has not been rescheduled or descheduled. Section 280E is fully in effect.

The practical consequence is severe. A cannabis dispensary or cultivation facility cannot deduct rent, payroll, utilities, marketing, insurance, professional fees, or any other ordinary business expense. The only offset available is cost of goods sold (COGS), which survives because COGS is treated as an adjustment to gross receipts rather than a “deduction” within the meaning of 280E. This distinction comes from the Tax Court’s holding in Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner (CHAMP) and subsequent cases.

The result is an effective tax rate that can exceed 70% for plant-touching businesses. That rate makes the question of what qualifies as “trafficking” enormously consequential.

Which businesses are ancillary and outside 280E?

A business is ancillary to the cannabis industry if it provides goods or services to cannabis operators without itself handling, growing, processing, distributing, or selling the plant or its derivatives. Common examples include consulting firms that advise on licensing, compliance, or operations; equipment manufacturers and suppliers (lighting, HVAC, extraction machinery); branding and marketing agencies; software and technology providers (seed-to-sale tracking, point-of-sale systems); security companies; and landlords who lease real estate to cannabis tenants.

These businesses earn their revenue from the cannabis industry, but they do not “consist of trafficking” in a controlled substance. Section 280E does not apply to them. They file their returns like any other business, claiming all ordinary and necessary deductions under IRC 162.

The critical factor is the nature of the activity, not the identity of the customer. A landlord who leases warehouse space to a cannabis cultivator is in the real estate business. A consultant who helps a dispensary obtain its state license is in the consulting business. Neither is trafficking in marijuana.

Can ancillary activities be split into a separate entity?

Yes, and this is where the real planning opportunity lives. Many cannabis operations perform functions that are genuinely ancillary to the plant-touching business. Management and administrative services, intellectual property development, real estate ownership, and equipment leasing are all activities that can be housed in a separate entity. That separate entity provides services to the cannabis operation under a contract, collects fees, and claims normal deductions against those fees.

The structure works like this. Entity A is the cannabis operator (dispensary, cultivator, or processor). It touches the plant and is subject to 280E. Entity B is a management company, IP holding company, or real estate company. It does not touch the plant. Entity B provides services to Entity A and charges fees. Entity B claims full deductions. Entity A’s payment to Entity B is a cost that, depending on the nature of the service, may qualify as COGS or may simply be a nondeductible expense under 280E. Either way, the income that flows through Entity B is taxed at normal rates with normal deductions.

The net effect is that a portion of the economic profit from the cannabis operation is taxed at a dramatically lower effective rate.

Three structures dominate this space: management companies, IP licensing arrangements, and real estate holding companies.

How does a management company structure work?

The cannabis operator forms a separate entity (typically an LLC or S corporation) to provide management, administrative, and back-office services. The management company employs the administrative staff, handles bookkeeping, HR, compliance, and general operational oversight. It charges the cannabis operator a management fee, usually calculated as a percentage of revenue or a flat monthly amount.

The management company is not trafficking in a controlled substance. It is providing management services. Its income is subject to normal taxation, and it claims full deductions for the wages it pays, the office space it rents, and the other costs it incurs.

What about IP licensing arrangements?

A cannabis brand often has significant intellectual property: trademarks, trade names, proprietary cultivation methods, formulations, standard operating procedures, and marketing materials. An IP holding company can own these assets and license them to the cannabis operator for a royalty fee.

The IP holding company is in the business of licensing intellectual property, not trafficking in marijuana. Its royalty income is subject to normal taxation, and it can deduct the costs of developing, maintaining, and protecting the IP. The cannabis operator’s royalty payment may or may not be deductible (280E will deny it if it is not allocable to COGS), but the income earned by the IP company is taxed at a normal rate with full deductions.

This structure is most effective when the IP has genuine value and the royalty rate reflects what an unrelated party would pay in an arm’s length transaction. A 5% royalty on revenue for a well-known cannabis brand with consumer recognition is defensible. A 40% royalty for a brand nobody has heard of is not.

How does real estate leasing fit into 280E planning?

Real estate is the cleanest ancillary separation because the activity is unambiguously distinct from cannabis operations. A real estate holding company owns the property (cultivation facility, dispensary storefront, processing warehouse) and leases it to the cannabis operator. The holding company is in the real estate business. It collects rent, claims depreciation, deducts property taxes, insurance, maintenance, and mortgage interest, and reports net rental income.

The cannabis operator’s rent payment is a cost of doing business, but under 280E it is generally nondeductible (unless allocable to COGS, which is possible for cultivation facility rent under the CHAMP framework). The key benefit is that the rental income flowing through the real estate entity is taxed normally, and all associated real estate expenses are fully deductible.

For a deeper look at how cannabis real estate leases interact with 280E, depreciation, and cost segregation, see our guide to cannabis real estate leasing tax treatment.

What does the IRS look for in these structures?

The IRS is well aware of management company, IP licensing, and real estate structures in the cannabis industry. It does not automatically disqualify them, but it applies heightened scrutiny. Three tests matter most.

Economic substance. The ancillary entity must do real work and bear real economic risk. A management company that exists only on paper, has no employees, performs no actual services, and simply collects a fee is a sham. The entity needs its own bank account, its own books, its own contracts, and its own operational substance.

Arm’s length pricing. The fees, royalties, or rents charged between related entities must reflect what unrelated parties would agree to in a comparable transaction. A management fee of 15% of revenue might be reasonable for a full-service management arrangement. A fee of 50% of revenue for basic bookkeeping is not. The IRS can reallocate income under IRC 482 if the pricing is not arm’s length.

Genuine business purpose. The separation must have a business reason beyond tax avoidance. Legitimate reasons include liability protection, attracting outside investors into the real estate without exposing them to cannabis licensing risk, or separating management talent that serves multiple cannabis clients. A structure that exists solely to move income out of a 280E entity, with no operational justification, is vulnerable to challenge.

The IRS has won cases where taxpayers created shell entities with no real operations and allocated expenses to them artificially. It has lost cases where the ancillary entity had genuine substance, independent operations, and arm’s length pricing. The quality of the structure matters enormously.

What documentation should ancillary entities maintain?

Ancillary entities need to build and maintain a paper trail that demonstrates substance and arm’s length terms. At a minimum, this means written service agreements or leases with defined scope, deliverables, and pricing; contemporaneous transfer pricing documentation supporting the fee or royalty rate; separate bank accounts with actual cash flows (not just journal entries); separate books and records; evidence of services actually performed (time records, deliverables, correspondence); and, for real estate entities, standard commercial lease terms and independent appraisals.

If the IRS audits and the ancillary entity cannot produce this documentation, the structure will not survive. The time to build the file is when the structure is created, not when the audit notice arrives.

How do payroll and employment taxes factor in?

Payroll is one of the largest costs in cannabis operations, and where employees sit (in the plant-touching entity versus the ancillary entity) has direct 280E consequences. Wages paid by the cannabis operator are generally nondeductible under 280E unless they are allocable to COGS (production labor in a cultivation facility, for example). Wages paid by the management company for administrative and back-office functions are fully deductible by the management company.

The allocation of employees between entities must follow reality. An employee who spends 100% of their time on dispensary sales cannot be moved to the management company payroll to preserve the deduction. An employee who handles compliance, accounting, and HR across the organization can legitimately be employed by the management company.

For a detailed treatment of payroll and employment tax issues specific to cannabis businesses, including the COGS allocation for production labor, see our guide to cannabis payroll and employment taxes under 280E.

What happens if 280E is repealed or rescheduled?

As of September 2026, there is no enacted legislation repealing 280E, and marijuana remains Schedule I. Various proposals have circulated in Congress over the years, and the rescheduling process has been discussed at the administrative level, but nothing has changed the legal status quo.

If marijuana were rescheduled to Schedule III or lower (or descheduled entirely), 280E would no longer apply to marijuana businesses because the statute only covers Schedule I and II substances. If that happens, the ancillary entity structure would lose its primary tax motivation, though it might still serve liability, operational, or investment purposes.

Planning should be based on the law as it exists, not on speculation about future changes. Any taxpayer who files a return claiming deductions on the assumption that 280E has been repealed, when it has not, is filing an incorrect return.

Is this structure worth the complexity?

For a cannabis operator paying an effective tax rate above 60%, even a modest reallocation of income to a properly structured ancillary entity can save tens of thousands of dollars annually. The complexity (separate entities, separate books, transfer pricing documentation, additional tax returns) is real, but the tax savings at these effective rates almost always justify it.

The key is doing it right. A hastily assembled management company with no economic substance will not survive IRS scrutiny and may create additional problems (penalties, accuracy-related penalties under IRC 6662, and the cost of defending the position). A well-structured, well-documented ancillary entity with genuine operations and arm’s length pricing is a legitimate and defensible planning tool.

Related guides:

• Cannabis Cost Of Goods Sold Cogs Calculation
• Cannabis Entity Structure Llc Scorp C Corp
• Cannabis Irs Audit Risk Compliance
• Cannabis Payroll Employment Tax 280E
• Cannabis Real Estate Leasing Tax Treatment

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.