The 7 Biggest Buzz Killers That Can Ruin Your Cannabis Business

Running a cannabis business is hard enough without making costly mistakes that could cost you six figures or shut down your operation entirely. Here are the seven most dangerous mistakes cannabis operators make—and how to avoid them.

Mistake #1: Misunderstanding Cannabis Federal Taxation (280E)

Cannabis is still federally illegal, which means you're technically "trafficking in a controlled substance" in the eyes of the IRS. This triggers Section 280E of the tax code, which was designed to prevent drug dealers from deducting business expenses.

What 280E Actually Means

Section 280E states: "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 consists of trafficking in controlled substances."

Translation: You can't deduct normal business expenses like marketing, rent, utilities, or salaries. Your ONLY deduction is Cost of Goods Sold (COGS).

The Real Tax Burden

Here's what this looks like in practice:

Normal Business:
Revenue: $550,000
COGS: $200,000
Operating Expenses: $200,000
Taxable Income: $150,000
Tax (21% rate): $31,500

Cannabis Business Under 280E:
Revenue: $550,000
COGS: $200,000
Operating Expenses: $200,000 (NOT DEDUCTIBLE)
Taxable Income: $350,000
Tax (21% rate): $73,500

You're paying $42,000 MORE in taxes on the exact same business operations. Your effective tax rate isn't 21%—it's closer to 40-70% of actual profit.

TLDR:

Cannabis businesses can only deduct Cost of Goods Sold (COGS), not regular business expenses. This means your tax rate is effectively 40-70% instead of 21%. Maximizing COGS legally becomes your entire tax strategy.

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Mistake #2: Getting COGS Accounting Wrong

Since COGS is your only legal deduction, getting it right is critical. Get it wrong, and you either pay way too much in taxes or face massive audit penalties.

The COGS Challenge

IRS Section 471 details what qualifies as inventory and COGS, and it's COMPLICATED. It requires advanced cost accounting that most bookkeepers simply aren't trained to do.

The work must be done year-round, not just at tax time, or you'll lose the opportunity to maximize your only deduction.

What You Can Include in COGS

Clearly Allowable: Seeds, soil, nutrients, water for growing, grow lights electricity, packaging, testing fees, direct labor for growing/trimming/processing.

Requires Allocation: Rent (by square footage), utilities (production vs. retail), equipment depreciation, supervision labor.

Never Deductible: Marketing, administrative salaries, legal fees, insurance (except production-specific), travel, office supplies.

The Two Major Problems

1. Not maximizing COGS: You don't have an expert cost accountant working year-round to legally maximize what can be allocated to COGS.

2. Allocating too aggressively: Your accountant puts too much into COGS to lower taxes, but when the IRS audits you (and they will), you face huge penalties and interest.

TLDR:

COGS accounting is complex and must be done monthly, not annually. You need an expert cost accountant who knows IRS Section 471 and can maximize your deduction without triggering audit penalties.

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Mistake #3: Ignoring the 100% Audit Reality

The cannabis industry approaches 100% audit rates. That's not a scare tactic—it's reality.

Why Cannabis Businesses Get Audited

Low-Hanging Fruit: IRS agents know cannabis businesses are profitable, complex, and subject to 280E. From their perspective, auditing cannabis has a very high return on investment.

Pattern Recognition: The IRS has developed audit protocols specifically for cannabis. Agents are trained on what to look for and where businesses typically make mistakes.

Federal-State Tension: Even though you're legal at the state level, cannabis is still Schedule I federally. Audits serve both tax enforcement and the broader prohibition agenda.

What the IRS Will Demand

• Complete documentation of all costs allocated to COGS
• Justification for every allocation decision
• Time tracking for labor costs (production vs. administrative)
• Receipts and invoices for every claimed cost
• Inventory tracking records
• Reconciliation between POS, inventory tracking, and financials

The Real Cost of Audit Mistakes

Example: $75,000 in improper deductions leads to:

• $15,750 in additional taxes (21% rate)
• $3,950 in compounding interest (3 years)
• $3,900 in penalties (20%)
• $15,000-30,000 in CPA/attorney fees

Total cost: $40,000-50,000 to fix a $75,000 mistake. And that's just one year.

TLDR:

Cannabis businesses WILL be audited. Without proper documentation and defensible COGS allocation, you'll face back taxes plus 20% penalties plus compounding interest plus legal fees. A $75,000 mistake costs $40,000-50,000 to fix.

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Mistake #4: Using Generic Accounting Software and Practices

Cannabis isn't retail. It operates on a technology ecosystem that's completely unique to the industry.

The Technology Stack Problem

POS Systems: You're not using Square or Clover. You're using Cova, Treez, or Flowhub—systems built specifically for cannabis compliance.

Seed-to-Sale Tracking: Your inventory doesn't just track quantity and value. It tracks individual plants with RFID tags through every growth stage, following state requirements through systems like Metrc (29+ states) or BioTrack (9-10 states).

Multi-Channel Sales: Sales come through walk-in, Leafly, Weed Maps, Dutchie, Jane Technologies, and delivery services—each with different margins and profitability profiles.

Payment Processing: Bill.com won't work with you. You need specialized solutions like Automate for bill pay and Paragon for payroll.

What Generic Accountants Miss

Traditional accountants lump everything into a single "Sales" account. They don't track product-level profitability. They don't understand how your POS integrates with seed-to-sale systems.

Result: You might be selling tons of flower but losing money on every transaction while your high-margin vape cartridges sit on shelves.

TLDR:

Cannabis operates on a unique technology stack (Metrc, Treez, Dutchie, specialized payment processors) that generic accountants don't understand. Without proper integration and product-level tracking, you're making decisions blind.

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Mistake #5: Operating Without Proper Banking

Cannabis remains federally illegal, which creates massive banking challenges. Many businesses resort to all-cash operations, which creates massive risks.

The Cash Operation Problem

• Security Risk: Large amounts of cash make you a target for robbery
• Operational Burden: Paying employees, vendors, and taxes in cash is time-consuming and risky
• Audit Red Flags: All-cash operations raise IRS suspicions
• Banking Violations: "Smurfing" (making small deposits to avoid detection) is illegal

Banking Solutions Now Exist

In recent years, many banking institutions have joined the industry. Nearly every cannabis-legalized state now has banking options—typically smaller credit unions and local/state banks.

Cannabis businesses now have access to:

• Checking and savings accounts
• Credit cards
• Loan financing

Important Caveat

Many of these banks boast about FDIC insurance. However, FDIC is a federal program, and it has never been tested for cannabis businesses. There's no way to know if FDIC insurance would be honored if there was an event that required it.

Still, having banking options is far better than operating all-cash. USE THEM.

TLDR:

Banking options for cannabis now exist in almost every legal jurisdiction through smaller credit unions and local banks. While FDIC protection is uncertain, having legitimate banking is far safer than all-cash operations.

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Mistake #6: Using the Wrong Software Solutions

Being illegal federally makes many software providers refuse to work with cannabis businesses out of fear of running afoul of federal law.

The Software Problem

Many standard business solutions won't work with cannabis:

• Payroll processors
• Point-of-service systems
• HR software
• Inventory management systems
• Security systems

Your Two Options

Option 1: Cannabis-Friendly Existing Software
Use smaller companies brave enough to work with cannabis. These often lack the features and polish of larger providers.

Option 2: Cannabis-Specific Software
Use software built solely for the cannabis industry. These are improving rapidly but often are:

• Clunky and light on features
• Higher error rates than established software
• More expensive
• Steep learning curve as the industry develops

TLDR:

Standard business software often refuses cannabis clients. You're limited to smaller cannabis-friendly providers or cannabis-specific solutions that are still developing. Smart operators must navigate these limitations carefully.

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Mistake #7: Not Finding Qualified Professional Help

Most professional service providers are fearful to work with cannabis operators out of fear of running afoul of their licensing and certifying bodies.

Who's Afraid to Work With You

• Insurance agents
• IT experts
• Attorneys
• Certified Public Accountants
• Business consultants

The Fear Is Often Unfounded

Many governing bodies—like the American Institute of CPAs—have indicated that professionals servicing cannabis clients should not be concerned about running afoul of standards based solely on the client's industry.

Cannabis operators still need expert accounting, legal, and insurance work. The fear is largely perception, not reality.

The Solution

Find professionals who specialize in cannabis. Networks exist of CPAs, attorneys, insurance agents, business valuation experts, and auditors who specifically serve cannabis businesses.

These specialists understand:

• 280E compliance and COGS optimization
• State-specific regulations
• Cannabis technology stacks
• Banking and payment challenges
• Product-level profitability tracking

TLDR:

Many professional service providers fear cannabis clients unnecessarily. Find specialists who focus on the industry and understand the unique challenges—they'll save you from expensive mistakes.

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Conclusion: The Stakes Are High

Making any ONE of these mistakes can:

• Cost your business six figures in penalties and back taxes
• Ruin your exit strategy when you try to sell
• Shut down your business entirely

The Good News

If you're making any of these mistakes—or think you might be—there's help available.

A proper cannabis CPA can:

• Maximize your COGS legally to lower your taxes
• Keep you audit-ready 24/7-365
• Identify leaks you're missing that cost you money
• Provide peace of mind that your financials are correct

Real Example

One dispensary allocated $600,000 TOO MUCH into COGS last year, underestimating their tax liability by $126,000. By amending the return before the audit, they potentially saved another six figures in penalties and interest from the IRS.

That dispensary owner now sleeps with peace of mind knowing their tax return is CORRECT.

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What To Do Next

Don't wait for an IRS audit to discover you've been doing your accounting wrong. Get an expert review of your books, COGS allocation, and tax strategy now—before it costs you six figures.

Best case: You discover opportunities to legally reduce your taxes.
Worst case: You get peace of mind that your ducks are in a row.

The cost of getting this wrong is too high to guess.

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