Cannabis financial statements under 280E explained

Why cannabis statements have to be read twice

An ordinary company’s income statement and tax return tell roughly the same story. A cannabis company’s do not. Section 280E disallows every deduction and credit for a business trafficking in a Schedule I or II substance, and adult-use marijuana was still in Schedule I in September 2026. Cost of goods sold survives because it is subtracted in arriving at gross income and is not a deduction.

The result is two sets of numbers from the same ledger:

• Book view. Revenue, less cost of goods sold, less operating expenses, equals pre-tax income. This is what the owner sees in the accounting software.
• Tax view. Revenue, less cost of goods sold, equals taxable income. Operating expenses are ignored.

This guide is about reading and recasting the statements. What the statute says and the case law behind it are on 280E explained for buyers and sellers. How the result flows into price is on how 280E affects valuation.

What the income statement does and does not show

Read a cannabis income statement from the top, and stop at four places.

Revenue. Check whether it is shown before or after discounts, loyalty redemptions, and taxes collected from customers. Excise and sales taxes collected at the register are not revenue. Some small operators book them as revenue and expense them later, which inflates both lines.

Cost of goods sold. This is the most important line on the page, because every dollar in it reduces federal tax and every dollar outside it does not. Ask for the detail by account, not the total.

Operating expenses. These are real and must be paid, but for adult-use income they produce no federal tax benefit. A dollar of rent costs a dollar. In an ordinary business taxed at 21% it costs 79 cents after tax.

Income tax. In a C corporation the tax expense appears at the bottom and is often larger than pre-tax income. In an LLC or S corporation it does not appear at all, because the owners pay it personally. A pass-through’s statements can therefore look far healthier than the business is. Look at owner distributions in the equity section: a large share of them is usually going to the IRS.

The cost of goods sold line: where the risk sits

The IRS position, in Chief Counsel memorandum 201504011, is that a cannabis business computes cost of goods sold under the section 471 inventory regulations as they stood when 280E was enacted in 1982. The later and broader section 263A capitalisation rules cannot be used to move otherwise non-deductible expenses into inventory. The Ninth Circuit agreed in Harborside in 2021.

What that means by type of business:

Business	Belongs in cost of goods sold	Does not belong
Retailer or delivery (reseller)	Invoice price of product, less discounts, plus freight-in and other costs of acquiring it	Store rent, budtender wages, security, marketing, delivery drivers, owner salary
Cultivator (producer)	Seeds and clones, nutrients, grow labour, utilities, facility rent and depreciation for production space, production supervision	Sales staff, marketing, general administration, distribution to customers
Manufacturer (producer)	Biomass and inputs, production labour, packaging, lab testing of product, production-space costs	Brand marketing, sales commissions, corporate overhead

Doing some light processing does not turn a reseller into a producer. In Richmond Patients Group (2020) the Tax Court held that a dispensary that trimmed, dried, packaged, and labelled purchased cannabis was still a reseller. The differences by license are covered in 280E by license type.

When you read a seller’s statements, compare gross margin to peers. A retailer reporting a gross margin well below the range in the benchmarks guide may simply be a discounter. It may also have loaded operating costs into cost of goods sold. The account detail tells you which.

The tax return: three pages to read first

The return shows what position the company actually took. Three items matter most.

1. Form 1125-A. The IRS says filers of Forms 1120, 1120-S, and 1065 attach Form 1125-A if they report cost of goods sold. It shows opening inventory, purchases, labour, other costs, and closing inventory. Compare each line to the books. A large “other costs” line needs an explanation.
2. The deductions section. If a plant-touching adult-use company is deducting rent, wages, and advertising on page 1 as if 280E did not exist, it has taken an aggressive filing position, and the unpaid difference is a liability whether or not it is on the balance sheet.
3. Schedule M-1. On a corporate return this schedule reconciles income per books with income per return, and line 5 lists expenses recorded on the books but not deducted. For a 280E filer that line should be large, roughly the operating expenses. Corporations with total assets of $10 million or more file Schedule M-3 instead, and very small corporations with receipts and assets both under $250,000 need not complete it.

If the books, Form 1125-A, and the reconciliation schedule do not agree with one another, stop and find out why before going further.

Worked recast: from book income to after-tax cash

Illustrative only. One adult-use store, taxed as a C corporation at the 21% federal rate. State income tax is ignored. All figures are invented for arithmetic.

Step 1: the statements as presented

Line	Amount
Revenue, net of discounts and taxes collected	$3,000,000
Cost of goods sold, per books and per return	$1,740,000
Gross profit	$1,260,000
Operating expenses, including $60,000 depreciation and $40,000 interest	$1,010,000
Book income before income tax	$250,000

Step 2: normalize earnings

Adjustment	Amount	Evidence a buyer will want
Book income before income tax	$250,000	Financial statements
Add back depreciation	$60,000	Fixed asset schedule
Add back interest	$40,000	Loan statements
Add back owner pay above a market manager’s salary	$80,000	Payroll records; market salary support
Add back one-time legal fees for a settled dispute	$30,000	Invoices; settlement agreement
Subtract rent increase to market, because the owner’s building is leased to the store below market	($50,000)	Lease; rent comparables
Normalized EBITDA	$410,000

Step 3: the book-to-tax bridge, as filed

Line	Amount
Revenue	$3,000,000
Less cost of goods sold as filed	$1,740,000
Federal taxable income as filed	$1,260,000
Federal tax at 21%	$264,600
Book income before tax, less federal tax as filed	($14,600)

The store made $250,000 before tax and lost $14,600 after it. That is the single most important thing an outsider misses when reading cannabis statements.

Step 4: the buyer’s recomputation

The account detail shows $90,000 of store payroll and store rent inside cost of goods sold. A reseller cannot inventory those costs.

Line	Amount
Cost of goods sold as filed	$1,740,000
Less store payroll and rent moved to operating expenses	($90,000)
Cost of goods sold, recomputed	$1,650,000
Federal taxable income, recomputed	$1,350,000
Federal tax at 21%	$283,500
Additional tax per year against the return as filed	$18,900
Exposure across three open years, before penalties and interest	$56,700

Step 5: what a new owner would keep

Line	Amount
Normalized EBITDA	$410,000
Less federal tax, recomputed	($283,500)
After-tax cash before debt service and capital spending	$126,500

A buyer who applied a multiple to $410,000 without Step 5 would be pricing cash that does not exist. The reclassification in Step 4 does not change book income, because the $90,000 moves from one expense line to another. It changes tax. You can run your own figures in the 280E effective tax rate calculator, and further priced examples are on cannabis valuation worked examples.

Reading the balance sheet

The income statement shows one year. The balance sheet shows what has piled up.

• Income taxes payable. Compare the balance to the tax computed in your bridge, less payments you can trace to bank statements. A small payable next to a large computed tax means the tax was underpaid or never accrued.
• Uncertain tax positions. Companies with audited statements that filed on the basis that 280E did not apply to them book the difference as a liability. Trulieve reported $668.4 million of uncertain tax position liabilities at 31 December 2025. Small private companies often take similar positions and record nothing.
• Open years. The IRS generally has 3 years to assess, 6 if more than 25% of gross income was omitted, and no limit where no return was filed. Unfiled years never close.
• Sales, excise, and payroll taxes payable. These are taxes collected or withheld from others. Arrears here are more serious than income tax arrears and often carry personal liability for owners. See tax liabilities and holdbacks in a sale.
• Inventory. The balance should agree with a track-and-trace inventory report priced at cost. Production overhead capitalised into inventory is proper for a grower or manufacturer; check that the method is consistent year to year, because a change shifts profit between periods.
• Cash. Cash on hand in a vault is common. It should be supported by count sheets and tie to deposits and cash payments; see cash handling and payment processing.
• Related-party balances. Loans from owners, amounts due from affiliated management or real estate companies, and unpaid rent to an owner’s entity all need to be settled or priced. Lenders and investors behind those balances may also be parties the regulator should know about.

Medical and adult-use in the same set of books

The order published on 28 April 2026 placed marijuana subject to a state medical marijuana license in Schedule III. Treasury said the change will first apply for the full taxable year that includes the effective date and that guidance would address apportionment for businesses with both activities. No formal IRS notice had issued as of September 2026.

For statements, that means a dual operator should now keep, at a minimum:

1. Revenue and cost of goods sold by medical and adult-use sale, which the point-of-sale system already records.
2. Direct expenses coded to the activity they serve, where that can be identified.
3. A documented, consistent method for shared costs such as rent and payroll, pending IRS guidance on what method is acceptable.

A buyer will give credit for medical-side tax savings only where the split is supported by records. Scenario arithmetic is on rescheduling tax scenarios. State income tax is a separate calculation: a number of states allow cannabis businesses to deduct ordinary expenses on the state return regardless of 280E, as listed on state 280E decoupling.

A buyer’s checklist for 280E-burdened financials

1. Obtain three years of statements, complete returns with all schedules, and the general ledger.
2. Tie revenue to point-of-sale, track-and-trace, bank deposits, and sales tax returns; the method is on verifying revenue with track-and-trace data.
3. Get cost of goods sold by account and rebuild it under the reseller or producer rules.
4. Compare the books, Form 1125-A, and the book-to-tax reconciliation. Explain every difference.
5. Recompute federal tax for each open year. Compare it with tax paid, using IRS account transcripts and bank records.
6. Identify the filing position: conservative, aggressive cost of goods sold, or 280E not applied.
7. For pass-throughs, model tax as the new owner will bear it, not as the seller’s personal return shows it.
8. Separate medical from adult-use where both exist.
9. Normalize EBITDA with documented add-backs only, then subtract recomputed tax to reach after-tax cash.
10. Turn the exposure you found into a price adjustment, a specific indemnity, or a holdback.

The wider request list is the cannabis due diligence checklist.

What sellers should prepare

A seller who presents the recast first controls the conversation. Prepare four figures, shown separately: normalized EBITDA with support for each add-back, federal tax as filed, after-tax cash, and, where part of the business is state-licensed medical, a pro forma for that share. Include a one-page memo describing how cost of goods sold is built and which costs were excluded.

If earlier returns took aggressive positions, discuss with a CPA whether to amend before going to market. A known, quantified liability can be priced. An unknown one makes buyers assume the worst. The preparation sequence is on preparing a cannabis business for sale.

A broker will typically ask for these figures before giving an opinion of value, and you can talk through what yours would show on a free 20-minute intro call. This guide is general education, not tax or accounting advice, and the examples are simplified.