Cannabis Payroll and 280E: How to Maximize Your COGS Deductions

Why Payroll Is Your Biggest 280E Lever

For most cannabis businesses, payroll is the single largest operating expense — often 30-50% of revenue. Under IRC Section 280E, only labor costs directly tied to production qualify as deductible Cost of Goods Sold (COGS). Every dollar of payroll you can legitimately classify as direct production labor is a dollar that reduces your taxable income.

The problem? Most cannabis operators classify all payroll as a single line item, missing thousands in deductions. Proper payroll allocation between production (deductible) and non-production (disallowed) is where the real savings happen.

Which Employees Qualify as COGS Labor?

The IRS allows cannabis businesses to include direct labor in COGS under IRC 263A and Revenue Procedure 2010-13. Qualifying roles typically include:

• Cultivation staff — Growers, trimmers, harvest workers, and anyone handling plants directly
• Extraction technicians — Lab workers producing concentrates, edibles, or other processed products
• Packaging and labeling — Staff preparing products for retail sale
• Quality control — Testing, inspection, and compliance-related production roles
• Inventory management — Warehouse staff receiving, storing, and managing cannabis inventory

Which Employees Are Disallowed?

Non-production roles cannot be deducted under 280E, regardless of how essential they are to your business:

• Budtenders and dispensary sales staff
• Administrative assistants and office managers
• Marketing and social media staff
• Owners and executives (unless performing production duties)
• Delivery drivers (post-sale distribution)
• Security personnel

The Split-Role Problem

Many cannabis employees wear multiple hats. A cultivation manager might spend 60% of their time on production and 40% on administrative tasks. A dispensary owner might work the extraction lab three days a week. In these cases, payroll must be allocated proportionally based on documented time tracking.

The IRS expects reasonable, consistent allocation methods with supporting documentation. Time sheets, duty logs, and job descriptions are your first line of defense in an audit.

Payroll Tax Implications

An important nuance: even though wages for non-production staff are disallowed as an expense deduction under 280E, the employer portion of payroll taxes (FICA, FUTA, state unemployment) for production employees can be included in COGS. This is an often-overlooked deduction that adds up quickly.

• Employer FICA (7.65%) on production wages — deductible as COGS
• Workers' compensation insurance for production staff — deductible
• Health benefits for production staff — potentially deductible (consult your CPA)

Real Example: The $47,000 Difference

Consider a dispensary with cultivation doing $3M in revenue with $900K in total payroll:

• Without allocation: $0 payroll in COGS (all classified as operating expense, disallowed)
• With proper allocation: $540K of production payroll in COGS (60% production staff)
• Additional payroll taxes on production wages: ~$41K added to COGS
• Tax savings at ~37% effective rate: approximately $47,000 per year

How to Set Up 280E Payroll Tracking

1. Categorize every employee as "production," "non-production," or "split"
2. For split roles, establish a documented time allocation method
3. Track hours consistently — weekly timesheets signed by supervisors
4. Run payroll reports by 280E category each pay period
5. Reconcile production payroll to COGS monthly
6. Keep job descriptions current and aligned with actual duties