Across the United States, an increasing number of states have legalized cannabis for medical or adult use. That may sound like the end of prohibition, but at the federal level, cannabis remains classified as a Schedule I controlled substance. This contradiction creates a patchwork of rules and restrictions that continue to burden state-legal businesses. From taxes to banking to even crossing state borders, Natalie C. Diaz of our Cannabis, Hemp and Psychedelics group breaks down how federal prohibition still casts a long shadow over the cannabis industry.

The Tax Trap: Understanding IRS Rule 280E

For most businesses, tax season means accounting for everyday operating costs — rent, payroll, marketing, security, and the cost of goods sold. These deductions are a basic part of doing business.

But for cannabis companies, the Internal Revenue Code has a harsh surprise: Section 280E. This rule prohibits any business trafficking in Schedule I or II controlled substances from deducting “ordinary and necessary” expenses. That means cannabis businesses cannot deduct rent, payroll, or marketing, expenses every other legal business takes for granted. The only allowable deduction is the cost of goods sold (COGS), such as the raw materials used to produce cannabis products.

The result? Inflated tax bills. While a typical company might pay taxes on $300,000 of profit, a cannabis operator could owe taxes as if they earned $600,000 from the same revenue. The difference can easily reach tens of thousands of dollars annually, putting legal cannabis companies at a steep financial disadvantage.

In short, 280E punishes state-compliant businesses for operating within an industry that federal law still refuses to recognize.

The Banking Barrier: A Cash-Only Economy

Even if a cannabis business survives the tax burden, it faces another major obstacle: access to banking.

Because cannabis remains federally illegal, most financial institutions refuse to work with cannabis operators. Banks fear federal regulators could view them as complicit in money laundering or drug trafficking. This lack of access forces many cannabis companies to operate on a cash-only basis, leading to significant complications. Handling large amounts of cash increases the risk of theft, complicates payroll, and prevents access to traditional loans or credit lines that are essential for growth.

Without reliable banking, cannabis entrepreneurs must navigate a financial system that treats them as outlaws, despite following all state laws and regulations.

Crossing the Line: Interstate Challenges

Perhaps the most overlooked consequence of federal prohibition involves borders, even the invisible ones between neighboring states.

Inside a state with legal cannabis, businesses can operate freely within the bounds of local regulation. But crossing a state line with cannabis products immediately triggers federal jurisdiction. Because federal law governs interstate commerce, transporting cannabis across state borders — even between two states where it’s legal — remains a criminal act.

This restriction stifles efficiency and innovation. Multi-state operators can’t streamline supply chains, and smaller companies are confined to local markets. Until Congress acts to change federal law, state legalization stops cold at the border.

Playing by a Different Set of Rules

Despite rapid legalization across the country, federal prohibition ensures that cannabis businesses remain trapped in a gray area, legal in their states but burdened by federal restrictions. The effects ripple through every part of the industry: excessive taxes, limited banking options, and legal risks tied to geography itself.

Until federal law catches up with state reforms, cannabis businesses will continue to operate under a different and unequal set of rules.

To learn more about how federal prohibition continues to impact state-legal cannabis businesses, contact Natalie C. Diaz at ndiaz@mblawfirm.com or at 973-852-4235.

Share: