280E for NYC Dispensaries: What You Can Deduct and What Will Get You Flagged
New York state’s decoupling from IRC 280E is good news for New York dispensaries, as it provides significant tax relief at the state level. Federally, 280E still applies, prohibiting all cannabis businesses from deducting normal business expenses, including payroll, office equipment, marketing, lease payments, and more.
Under 280E, cannabis businesses can only deduct expenses related to the cost of goods sold (COGS), so dispensaries are particularly affected unless some part of their business is involved in cultivation, manufacturing, or packaging.
Though cannabis is legal in almost every state, the federal government still classifies it as a Class I (illegal) substance. IRC 280E was implemented to prevent drug traffickers from deducting expenses related to unlawful activities. Until the feds and the FDA declassify cannabis, all businesses engaged in the cultivation, manufacturing, sale, and distribution of marijuana must adhere to these rules.
In 2023, New York passed a bill that enables cannabis operators to deduct 280E-related expenses on their state returns. While the move provides much-needed relief, it also entails additional record-keeping and a second set of books detailing eligible costs.
NYC dispensaries must also be prepared to back up each expenditure with detailed documentation, as audits will almost certainly happen. Knowing what you can deduct and what might get you flagged is critical to ensure the process goes smoothly and you’re not being audited based on an avoidable mistake.
What NYC Dispensaries Can Deduct Under 280E
Ordinary business expenses that are not deductible on federal returns are allowable on state returns. These include:
Rent, lease, or mortgage payments
Advertising and marketing expenses
Payroll
Insurance
Professional services
If the dispensary is involved in manufacturing or packaging the products they sell, they are also able to deduct related costs as COGS, including the cost of securing, storing, and delivering the product.
Additionally, New York City offers city-level tax relief, allowing dispensaries to deduct business expenses from their NYC taxes – a nice bonus for any retail operation within the city’s jurisdiction.
To summarize what’s allowable and at what level:
Federal: expenses related to COGS only.
New York State tax returns: all ordinary business expenses.
New York City tax returns: all ordinary business expenses, including UBT and GCT.
What Dispensary Deductions Might Get Flagged?
Nobody loves audits. But if you’re in the cannabis business, chances are there is one in your future.
Because of its illegal status at the federal level and the complications of accounting in this highly complex environment, cannabis companies are always under the microscope. Your best defense is to ensure your books are clean and that you have detailed documentation to support all deductions. The record-keeping aspect of this process is cumbersome but worthwhile, especially with high-risk expenses that might pull extra scrutiny.
So, what are the auditors looking for? And what constitutes a red flag? Here are a few examples:
Personal expenses disguised as business expenses. For example:
A personal vehicle is used to deliver product and listed as a delivery expense without adequate logs or documentation.
Home renovations documented as facility improvements.
Non-COGS expenses on your federal return (auditors look for these specifically):
Budtender salaries
Store rent
Security
Marketing expenses
Office equipment
Misclassified or overly inflated COGS expenses. IRS auditors are aggressive about proper classification. Don’t fall into this trap, as they will question every line item!
Attempting to classify salaries as being production-related when they’re not.
Including store security expenses in inventory storage costs
Professional services (like lawyers and accountants) can be a grey area. If you try to slip this in under COGS on your federal return, it’s a massive red flag. However, they are typically deductible at the state and city level.
Inflated shrinkage costs. Loss from theft or non-payment happens, but if you claim these expenses consistently or if they look much higher than they ought to be, look out.
High marketing costs. If your marketing costs are higher than your income or the ratios are too high, it will flag you at the state and city level.
State and federal returns show different taxable income. Even if it’s an accounting mistake, auditors will want to know why.
Inconsistent expenses from year to year. Dispensaries that have been in business for some time should have reasonably predictable, benchmarked expenses.
Rounding numbers. Be sure you are reporting what’s actually on the ledger.
How to Avoid Audit Issues
Since New York State and NYC have decoupled from 280E, NYC dispensaries are allowed to deduct many expenses they can’t claim on their federal returns.
While this is good news, it also necessitates that you maintain two separate sets of books—one with COGS expenses and another with all ordinary business and operating expenses allowable on state and local returns.
Ensure there is no overlap between federal and state books, as this can trigger an audit.
Additional tips and best practices include the following:
Maintain detailed documentation for everything—invoices, contracts, service agreements, employee timesheets, receipts, etc.
Keep an eye on industry benchmarks to ensure you’re in line with standards. This may help you avoid an auditor wondering, “Why is this unusually high?”
Document all significant variances, such as upgrades to the premises, remodels, new security systems, etc., and be ready to back up your claims.
Audit Risk Checklist
To summarize our 280E roundup for NYC dispensaries, here’s a list of deductions classified by risk.
Safe to Deduct for New York State and NYC Returns (non-federal)
Rent
Utilities
Wages
Marketing costs
Office supplies, software, etc.
Professional services
Security equipment and fees
Insurance (liability, property, workers comp)
Store repairs and maintenance
Banking fees and armored car services
Safe but High Audit Risk
The following must be well-documented, as they are often challenged in audits.
Business travel and meals. Keep receipts and provide business justification.
“Cash loss” from theft/shrinkage. Keep police reports or internal incident logs on file to back up your claims.
Owner vehicle expenses: document mileage in logs to prove business use.
Training or education costs must be tied to cannabis business operations.
Lobbying or license application consulting is okay locally, but keep it separate from federal books.
Large capital improvements. Keep construction contracts and proof of business use on file.
NEVER Deduct Federally
Can only attribute to COGS if directly tied to production. Dispensaries rarely qualify.
Rent (unless storage/production area is separate)
Wages (sales staff are not production staff)
Marketing and advertising costs
Security for the retail store
Admin salaries (bookkeepers, receptionists, etc.)
Legal fees for licensing or compliance
General business insurance
Utilities for retail space
The Bottom Line: Work with a Cannabis Tax Specialist to Avoid Audits
The cannabis tax specialists at Growise are well-versed in tax implications for NYC dispensaries. Set up a call today and let’s talk growth!