Should Your Cannabis Company Be an S-Corp? Here’s the Downside (and What to Watch Out For)

If you’re running a cannabis business, you’ve probably heard about S-corporations (S-corps) and wondered if they’re a smart move for your company. After all, S-corps are famous for helping entrepreneurs save on taxes—so why not go for it, right?

Not so fast. The cannabis industry is a different beast, and there are some big pitfalls to choosing S-corp status. Let’s break down what you need to know, without the legalese.

The Big Stumbling Block: Section 280E

Here’s the kicker: Cannabis companies can’t deduct most ordinary business expenses because of our old tax rule friend called Section 280E. This rule says that if you’re trafficking in federally illegal substances (yep, until we get rescheduling, cannabis still counts), you can only deduct your Cost of Goods Sold (COGS), not your rent, marketing, salaries, or most other expenses.

Why does this matter for S-corps?

The main tax benefit of an S-corp is avoiding double taxation: profits “pass through” to the owners’ personal tax returns, skipping the corporate tax. But, cannabis businesses can’t deduct ordinary business expenses (except cost of goods sold) because cannabis is still federally illegal. Electing S-corp status doesn’t change this. You’re still limited in what you can deduct, so the main tax advantage of an S-corp (avoiding double taxation) isn’t as beneficial here as it is for non-cannabis businesses.

You Have to Pay Yourself a Salary—Even If It Hurts

S-corps require owners who work in the business to take a “reasonable salary.” This is great for the IRS, but not always so great for you. That salary is subject to payroll taxes, and in a cannabis business—where every dollar counts—this can squeeze your cash flow even more.

Bottom line: You’re locked into payroll tax obligations, even if your business is just scraping by.

Ownership Rules Are Tight

S-corps have some strict ground rules:

• No more than 100 shareholders
• All shareholders must be U.S. citizens or residents
• Only one class of stock

In cannabis, where investment structures can get creative (think: friends, family, investors, and partners), these rules can box you in and limit your options.

More IRS Attention

S-corps are already on the IRS radar for making sure owners aren’t underpaying themselves to dodge payroll taxes (called the “reasonable compensation” issue). Cannabis businesses are doubly interesting to auditors. Translation: more paperwork, more scrutiny, and more stress because you’re doubling up on the IRS’s risk-o-meter!

State-Specific Headaches

Some states have their own quirks when it comes to S-corps and cannabis. You might find yourself facing unexpected state taxes or compliance hoops, depending on where you operate.

So, Is S-Corp Status Ever a Good Idea for Cannabis?

Sometimes, but it’s rare. The S-corp structure might make sense if:

• You’re profitable enough that payroll tax savings outweigh the downsides

But for most cannabis businesses, sticking with an LLC or C-corp gives you more flexibility and fewer headaches.

Final Thought

S-corps are awesome for lots of businesses, but cannabis isn’t “lots of businesses.” Between 280E, payroll rules, and state quirks, the downsides usually outweigh the perks.

If you’re thinking about making the S-corp leap, talk to a cannabis-savvy CPA first.

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Got questions or want to see a side-by-side comparison? Drop us a line—Happy to help!