How to Calculate Cannabis Taxes

Imagine running a cannabis business that seems to be thriving—until tax season hits. Suddenly, your revenue takes a pummeling from federal restrictions, hefty state excise taxes, and unexpected local fees. You’re left wondering: How much of your income do you actually get to keep? If you’re operating in the legal cannabis industry, understanding how taxation works isn’t just a financial necessity—it’s the difference between growth and bankruptcy.

Unlike traditional businesses, cannabis companies face restrictions at the federal level, heavy excise taxes at the state level, and unpredictable local tax policies, all of which add up to a significant financial burden. For business owners, failing to plan for these taxes can lead to financial strain, compliance issues, and even business closures.

As of 2025, 24 states have legalized adult-use cannabis, and over 38 allow medical cannabis. However, legalization doesn’t mean uniformity, as each state sets its own tax rates and structures, resulting in major cost differences for businesses—depending on their location. In California, a retailer might pay up to 35% in combined taxes, while in Oregon, total taxes may be closer to 17%. Some states tax cannabis based on weight, others by potency, and many apply multiple layers of taxation at different points in the supply chain.

On top of that, federal tax law (specifically IR Code Section 280E) makes things even more challenging. Since cannabis remains illegal at the federal level, businesses cannot deduct normal operating expenses like rent, payroll, or marketing. This means that while a regular retail business might be taxed on net profit, a cannabis dispensary is taxed on nearly its entire revenue—leading to effective tax rates as high as 70% in some cases.

This guide breaks down cannabis taxation at every level—federal, state, and local—with step-by-step calculations and real-world examples. Whether you’re a cultivator, manufacturer, distributor, or retailer, understanding your tax obligations is crucial to maintaining profitability and avoiding legal pitfalls.

Federal Taxation: The Overarching Framework

For most businesses in the U.S., taxation is fairly straightforward: calculate your revenue, deduct legitimate business expenses, and pay taxes on your net profit. But if you run a cannabis company, those basic rules don’t apply. The federal government treats cannabis as an illegal drug, and as a result, cannabis businesses are stuck paying a disproportionately high tax bill due to a little-known provision in Section 280E:

IRC Section 280E

Enacted in 1982, IRC Section 280E prohibits businesses involved in trafficking Schedule I or II substances from deducting typical business expenses from their gross income. However, cannabis businesses can deduct the Cost of Goods Sold (COGS), which includes expenses directly related to the production of goods sold, such as cultivation costs. Non-deductible expenses under 280E encompass rent, utilities, advertising, and employee salaries not directly tied to production. This results in a much higher taxable income and, consequently, a higher tax liability for cannabis businesses compared to other industries.

Impact on Cannabis Businesses

The inability to deduct standard business expenses leads to effective tax rates that are significantly higher than those of non-cannabis businesses. Some reports indicate that cannabis companies with integrated business models are paying effective tax rates of 75% to 80%, approximately twice the rate facing other businesses not subject to Section 280E.

Compliance Strategies

To tackle these challenges, cannabis businesses must adopt proactive compliance strategies, such as optimizing deductions within the allowable COGS framework and structuring operations to maximize deductible expenses. It’s essential for these businesses to work closely with tax professionals who are well-versed in IRC Section 280E to ensure compliance and minimize tax liabilities. Additionally, an effective approach is utilizing specialized point of sale (POS) systems designed for the cannabis industry. For instance, IndicaOnline’s POS system offers comprehensive compliance features tailored to meet state and local regulations.

The Real-World Impact of 280E

For a traditional business, the tax liability is calculated as follows:

Revenue – Expenses = Taxable Income

For a cannabis business, it looks more like:

Revenue – COGS = Taxable Income (with most other expenses ignored).

This means a cannabis retailer earning $1 million in revenue with $700,000 in total expenses (including rent, payroll, marketing, and COGS) could end up paying federal taxes as if they had $700,000 in profit, even though their actual profit might be just $300,000 or less. The result? Effective tax rates of 60-80%, compared to 21% for most corporations.

State and Local Taxation: Navigating the Complexities of Cannabis Levies

As the legal cannabis industry expands across the United States, understanding the intricate web of state and local taxation becomes crucial for businesses and consumers alike. Each state that has legalized cannabis implements its own tax structure, leading to a diverse landscape of fiscal policies.

Excise Taxes: Diverse Approaches to Cannabis Taxation

States employ various methods to levy excise taxes on cannabis, which are primarily categorized into price-based, weight-based, and potency-based taxes.

• Price-Based (Ad Valorem) Taxes: These taxes are calculated as a percentage of the retail or wholesale price of cannabis products. For instance, Colorado imposes a 15% excise tax on the average market rate of wholesale cannabis and an additional 15% sales tax at the retail level.
• Weight-Based Taxes: Some states tax cannabis based on the product’s weight. Alaska, for example, levies a tax of $50 per ounce on cannabis flowers and $15 per ounce on other parts of the plant.
• Potency-Based Taxes: A few states have adopted taxation based on the THC content of cannabis products. Illinois employs this method, taxing products with higher THC concentrations at higher rates.

Sales Taxes: Adding to the Consumer’s Burden

In addition to excise taxes, many states apply their standard sales tax rates to cannabis products. For example, California imposes a 7.25% state sales tax on retail cannabis sales, alongside a 15% excise tax.

Local Taxes: The Final Layer of Complexity

Municipalities often impose additional taxes on cannabis sales, which can have a considerable impact on the final cost to consumers. In California, local jurisdictions may levy additional sales taxes on top of state-imposed taxes, leading to varying tax rates across the state.

Understanding these varied tax structures is essential for businesses operating in the cannabis industry to ensure compliance and for consumers to be aware of the potential costs added to their purchases.

Mastering Cannabis Tax Calculations: A Step-by-Step Guide

A thorough understanding of the intricate tax obligations in the cannabis industry requires a clear, methodical approach. Here’s a comprehensive breakdown to help cannabis businesses determine their total tax liability accurately:

1. Calculate Gross Receipts

• Definition: The total revenue generated from all sales before any deductions.
• Action: Aggregate all income from product sales and related services within the tax period.

2. Determine Cost of Goods Sold (COGS)

• Definition: Direct costs associated with producing or acquiring the cannabis products sold.
• Components:
  • Cultivation Costs: Expenses for seeds, soil, nutrients, and direct labor involved in growing.
  • Processing Costs: Costs related to trimming, drying, and packaging.
  • Acquisition Costs: For retailers, the purchase price of products from wholesalers.
• Action: Maintain detailed records of all direct production and acquisition expenses.

3. Compute Federal Taxable Income

• Gross Income: Subtract COGS from gross receipts.
• Taxable Income: Due to IRC Section 280E, cannabis businesses cannot deduct standard operating expenses (e.g., rent, utilities, salaries unrelated to production). Therefore, taxable income remains equivalent to gross income.

4. Apply Federal Income Tax Rate

• Action: Apply the current federal corporate tax rate to the taxable income calculated above.

5. Calculate State Taxes

• Excise Tax: Varies by state and may be based on price, weight, or potency.
  • Example: In Colorado, there’s a 15% excise tax on the average market rate of wholesale cannabis.
• State Income Tax: Apply the state’s corporate income tax rate to the taxable income.
• Sales Tax: Levied on the retail sale of cannabis products.
  • Example: California imposes a 7.25% state sales tax on retail cannabis sales.

6. Include Local Taxes

• Action: Account for any additional taxes imposed by municipalities or counties where the business operates.

7. Summarize Total Tax Liability

• Action: Aggregate all federal, state, and local taxes to determine the total tax obligation.

Key Considerations:

• Meticulous Record-Keeping: Essential for substantiating COGS and ensuring compliance during audits.
• Stay Informed: Tax regulations in the cannabis industry are evolving. Consult with tax professionals regularly and monitor updates from state and federal agencies.

By following this structured approach, cannabis businesses can manage their tax responsibilities effectively and maintain compliance within this complex regulatory environment.

 Calculate Each Tax

• Excise Tax: Apply the excise tax rate to the product’s price.
• Sales Tax: Apply the sales tax rate to the subtotal after the excise tax has been added.
• Local Taxes: Apply any local tax rates to the subtotal after previous taxes have been added, if applicable.

Total Up the Taxes

Add all the calculated taxes to determine the total tax amount.

 Calculate the Total Price

Add the total tax amount to the original product price to determine the final amount the customer will pay.

Example Calculation:

Assume a product price of $100, with an excise tax of 15%, a sales tax of 8%, and a local tax of 5%, applied cumulatively:

• Excise Tax: $100 × 15% = $15
• Subtotal after Excise Tax: $100 + $15 = $115
• Sales Tax: $115 × 8% = $9.20
• Subtotal after Sales Tax: $115 + $9.20 = $124.20
• Local Tax: $124.20 × 5% = $6.21
• Total Tax Amount: $15 (Excise) + $9.20 (Sales) + $6.21 (Local) = $30.41
• Final Price: $100 (Product Price) + $30.41 (Total Tax) = $130.41

Best Practices:

• Stay Informed: Regular consultation with state and local tax authorities will provide you with the most current tax rates and regulations.
• Use Reliable POS Systems: Implement point of sale systems designed for cannabis businesses to automate tax calculations and ensure compliance.
• Maintain Accurate Records: Keep detailed records of all transactions and tax calculations to facilitate reporting and audits.

 The True Cost of Cannabis Taxes

Cannabis businesses don’t just sell a product—they have to contend with a financial and regulatory minefield where tax compliance is as critical as product quality. The numbers are clear: Between federal restrictions under IRC Section 280E, state excise taxes, local levies, and standard sales tax, a significant portion of revenue is claimed before a business even sees its profits. 

For dispensary owners, cultivators, and manufacturers, failing to calculate taxes correctly might not only represent an administrative oversight but could also spell financial disaster. Mistakes can lead to audits, fines, and compliance violations that put the entire business at risk. That’s why meticulous tax planning and record-keeping should be just as much a part of operations as inventory management and customer service.

But while the burden is heavy, there are ways to manage it. Leveraging cost of goods sold (COGS) deductions, structuring financial operations strategically, and using advanced cannabis-specific POS systems like IndicaOnline can help businesses track and automate tax compliance. Additionally, keeping up with regulatory changes at the state and federal level is essential as tax policies continue to evolve.

Ultimately, cannabis taxation isn’t solely about numbers—it also concerns survival in a high-stakes market. Businesses that understand their tax liability, optimize deductions within legal limits, and implement airtight financial strategies will be the ones that endure. Those that don’t? They’ll struggle to keep up. In this industry, the definition of knowledge isn’t restricted to power alone—it’s an essential part of a profitable operation.

Note: This article is for informational purposes only and does not constitute legal, tax, or financial advice. Cannabis tax laws vary by jurisdiction and are subject to change. Businesses should consult with a qualified tax professional, accountant, or attorney to ensure compliance with all applicable laws and regulations.