The regulated cannabis industry confronts a strange moment: long-awaited federal tax relief may arrive in 2026 as tariffs offset the benefits.
For years, operators have awaited the end of Section 280E, a federal tax rule that prevents cannabis businesses from deducting ordinary operating expenses like rent and payroll. Operators in Illinois estimate that 44% of 2024 operating expenses were nondeductible under 280E, according to regulatory disclosures. Using public financial filings, I estimate that 280E consumes 52% of operating profit. Assuming a 21% corporate tax rate, operators pay an $92 penalty for every $1,000 spent.
Relief finally looks possible. A December 2025 executive order accelerated rescheduling, which would remove operators’ exposure to 280E. However, even if that happens, the benefit may not show up on the bottom line.
Mapping the tariff impact
That’s because tariffs are increasing costs. Across the industry, operators report higher costs on inputs like packaging, vape hardware, and construction materials. For some, this is manageable.
For others, it’s not. One in six operators reports operating cost increases of 20% or more. With typical cannabis cost structures, even a modest 5% increase in input costs can erase most of the gains from eliminating 280E. At 10% or higher, tariff-driven cost increases can offset those gains entirely. In other words, cannabis companies may “spend” their tax relief before they ever see it.
The cruel irony: Who’s getting hit hardest?
Not everyone feels the pain in the same way, as I find a capital cost penalty and an inverse scale penalty:
Production vs. retail: A heavier burden falls on cultivation and infusion operations that rely on imported packaging products, buildouts, and high-tech hardware. One in six companies with cultivation and infusion operations (17%) report cost spikes exceeding 20%, while no dispensary-only company reported this impact.
The size gap: Smaller businesses are nearly three times as likely as larger companies to report cost increases exceeding 20% (17% vs. 6%). Larger operators can hedge by locking in long-term purchase agreements or pre-ordering inventory, smaller operators absorb higher costs in real-time.
An existing imbalance: What’s at stake in ending the 280E penalty?
Tariffs worsen an existing imbalance.
The 280E tax already hits smaller operators harder, as they report a greater percentage of nondeductible operating expenses due to 280E (45% vs. 37% of operating expenses), and make long-term choices based on tax constraints rather than business needs:
Investment freeze: Over half of Illinois cannabis firms (55%) report that 280E penalties have led them to cut discretionary spending — the very investments in new product development, research, and sustainable technologies required for a market to mature.
Labor trap: Roughly 52% of companies report altering hiring and employment practices, often leading to leaner staffing models that can impact everything from safety protocols to the customer experience.
Hard-to-reverse design choices: Perhaps most concerning, smaller companies (46%) report that their physical layouts are dictated by tax considerations, e.g., limiting outlays on retail sales space because it is harder to deduct. Unlike a spending policy, these physical facility layouts may be difficult to "reverse" once rescheduling relief finally arrives.
From survival to strategy
Eliminating 280E is undeniably positive, but it doesn’t guarantee a financial turnaround. Because it disproportionately burdens smaller operators, its elimination will reduce barriers for entrepreneurs and potentially increase competition.
Tariffs are different. They raise actual costs, and those costs are sticky. In an irony, many of these costs are tax-deductible, but that’s small comfort when the overall cost base climbs.
For many operators, especially smaller operators, the next phase isn’t about finally winning on taxes, it’s about surviving a new, higher cost structure.
About the author: Justin Leiby is a Professor of Accountancy in the Gies College of Business at the University of Illinois and faculty in Residence at the Cannabis Research Institute at the University of Illinois. His research and teaching focuses on auditing, governance, and risk management, and includes extensive collection and analysis of operational and financial data in the cannabis industry.
Story edited by Jeremy Berke.