280E IRS Audit Defense: $2.1M Assessment Reduced for Multi-Location Dispensary

Matter Overview

A multi-location cannabis dispensary operating in two states received an IRS examination notice targeting its prior three tax years. The IRS proposed a combined assessment of approximately $2.1 million based on its position that the company had impermissibly deducted ordinary business expenses beyond the cost of goods sold (COGS) allowed under Internal Revenue Code Section 280E. The IRS examiner also challenged the company's COGS methodology as overinclusive.

Work Performed

Hoban worked alongside the client's tax counsel on the regulatory and business-operations analysis that would be necessary to support the legal position. Our primary contribution was reconstructing the factual record around the company's distinct "trafficking" versus "non-trafficking" business activities — the central legal distinction under 280E as interpreted by Californians Helping to Alleviate Medical Problems (CHAMP) and subsequent Tax Court decisions.

The company operated a retail delivery service, a loyalty program administration function, and a compliance training division alongside its core dispensary operations. Hoban documented each of these as separable trade or business activities with distinct profit motives, separate employees, and independent revenue streams — the factual predicate for the position that 280E's disallowance did not reach those activities' deductions.

We also provided a regulatory-context brief to tax counsel explaining the Colorado and Arizona licensing frameworks — specifically, which operational activities were required by state regulators and therefore integral to the licensed business versus which were genuinely ancillary. This framing supported the argument that certain compliance costs were COGS-eligible rather than ordinary deductions.

Outcome

Following a two-round examination exchange and a formal protest, the IRS settlement reduced the proposed assessment by 63% — from $2.1 million to approximately $775,000. The settlement preserved the client's COGS methodology for future periods.

Lessons Learned

280E exposure is not fixed — it is a function of how well a company has documented the activities underlying each cost category. Operators who conflate all expenses into a single accounting bucket lose the factual foundation for the CHAMP argument. Building the evidentiary record for a potential audit should happen contemporaneously with business operations, not retroactively under examination pressure.

Engage Hoban Law Group

Hoban Law Group advises cannabis businesses on 280E compliance positioning, COGS methodology, and IRS examination defense. [Schedule a consultation](/consultation?source=matter&matter_slug=cannabis-280e-irs-audit-defense-2023&matter_type=cannabis-banking-280e).