In my last piece, I discussed strategies for optimizing COGS if you hold a rec-only cannabis license. So this next question is the one that puts money back in your pocket. Which expenses count as COGS, and which do not?
The answer starts with one split. Are you a retailer or a producer? That single question controls how much cost you can move into inventory, and the gap between the two is large.
A retailer buys finished product and sells it. Most dispensaries are retailers. Your rule is narrow. You can count what you paid for the product, plus the cost of getting it to your door. That is close to the whole list. The rent on your shop, your budtenders wages, your security guard, your marketing? None of it moves into COGS. 280E blocks it, and the reseller inventory rule will not let you pull it back. So a pure retail dispensary carries the heaviest tax load in the whole industry.
A producer grows or makes the product. Cultivators and processors are producers. Your rule is wider. You can fold in direct materials, direct labor, and a defined set of indirect production costs. The people trimming plants. The electricity running your grow lights. The part of your building used for cultivation. The testing tied to making the product. Those can ride into inventory and come off your gross income when the product sells. That is why a producer can sit well below a dispensary on tax burden, even in the same market with the same revenues.
Here is where you can get burned. A dispensary with a back room where staff repackage or lightly process product is still a reseller. The Tax Court said so plainly in the Harborside case. Owning a processing corner does not make you a producer. You must grow or manufacture the product to qualify. If you set your books up as a producer when you are really a retailer, you are relying on a tax position that falls apart under IRS scrutiny.
There is a common piece of bad advice worth killing right now. Some people point to Section 263A, the uniform capitalization rules, and say you can use it to shove more overhead into inventory. You cannot. The IRS said in official guidance that 263A cannot turn a disallowed expense into cost of goods sold. The Tax Court agreed. Drug traffickers, in the court’s words, do not get deductions, and 263A cannot create one through the back door.
You may hear about Section 471(c) too. It is a small-business provision, and some advisors pitch it as the move that kills 280E for operators under roughly thirty million dollars in gross receipts. Be careful. The IRS has stated flatly that a business subject to 280E cannot use 471(c) to escape it. No court has handed operators a win on this and there is no settled case law. If you take the position and lose, you owe the back taxes, plus interest, plus penalties, and you have painted a target on your return. I am not saying it can never be argued. I am saying it is an uncertain tax position that carries a risk worth measuring against your own tolerance as an operator.
So here is the honest picture. Where you sit in the supply chain sets your ceiling. A reseller has a low one. A producer has a higher one. And no clever section number rewrites that. The money is won or lost in how carefully you sort and document the costs you are genuinely allowed to count.
Want your COGS position reviewed before your next filing? Start here: highrock.co/contact
Next in the series, I get practical. How to build a cost system that holds up under IRS scrutiny, the mistakes that trigger audits, and where a sharp finance review pays for itself.
Melissa Diaz, CPA
Co-Owner & Partner, High Rock Accounting
High Rock Accounting delivers outsourced accounting, tax strategy, and fractional CFO services to cannabis operators. Melissa is a 2026 Forbes Best-in-State CPA.
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