How GAAP Inventory Rules Apply to Cannabis Businesses Under §280E
Why the “lower of cost and net realizable value” rule in GAAP doesn’t relieve cannabis operators from §280E tax restrictions.
Under GAAP, inventories are measured at cost and subsequently adjusted to the lower of cost and net realizable value. But for cannabis businesses, §280E prevents this GAAP write-down from reducing taxable income. The difference creates a permanent book–tax gap for operators.
Short Answer
GAAP requires cannabis businesses to value inventory at cost and, under ASC 330 and ASU 2015-11, adjust to the lower of cost or net realizable value (NRV). For tax purposes, however, §280E blocks the deduction of SG&A expenses, and NRV write-downs do not reduce taxable income. The result is a permanent book–tax difference that cannabis operators must manage carefully.
GAAP Requirements for Inventory
The primary U.S. accounting standard for inventory is ASC 330 (Inventory), as modified by ASU 2015-11. GAAP requires inventory to be measured at cost, and then written down to the lower of cost and net realizable value (NRV) if NRV falls below cost.
Cost basis under GAAP includes direct materials, direct labor, and both fixed and variable production overhead allocated on a systematic basis (ASC 330-10-30).
NRV is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
GAAP explicitly excludes selling expenses, general and administrative expenses, and abnormal waste from inventory valuation.
This approach aligns with the full absorption costing principle also required by the tax regulations under Treas. Reg. §1.471-11. Both frameworks insist that inventory should capture the full cost of production, not just direct inputs.
§280E and the Denial of Deductions
IRC §280E denies any deduction or credit for amounts paid or incurred in carrying on a trade or business that consists of trafficking in controlled substances. The only relief cannabis operators receive is through COGS, as permitted by IRC §471(a) (for retailers) or potentially §1.471-11 (for producers).
Key cases have confirmed this interpretation:
Patients Mutual (Harborside) — limited retailers to §471(a).
Alterman v. Commissioner — reinforced that resellers cannot invoke §1.471-11.
Canna Care, Inc. v. Commissioner — confirmed cannabis retailers cannot push SG&A into inventory.
Thus, while GAAP and tax law both embrace absorption costing, §280E draws a hard line: SG&A cannot be deducted, even when GAAP allows it as an ordinary business expense.
What is the GAAP–Tax Divergence
This creates a structural book–tax difference for cannabis operators:
GAAP books:
Inventory recorded at cost, adjusted to NRV if lower.
SG&A expensed on the income statement, reducing book income.
Tax return under §280E:
SG&A disallowed entirely, even if deductible under GAAP.
NRV write-downs ignored — tax law does not allow inventory to be reduced below cost due to anticipated selling losses.
Courts push GAAP and §1.471-11 not because GAAP controls tax, but because Treasury regulations deliberately aligned tax inventory rules with GAAP absorption costing. This gives the IRS and courts a shared benchmark. In cannabis cases, that alignment works against operators: GAAP itself excludes SG&A from inventory, and §280E makes those costs permanently nondeductible.
Example:
Suppose a cannabis producer records $1,000,000 in production costs and $250,000 in SG&A. At year-end, falling wholesale prices trigger a GAAP NRV write-down of $100,000.
GAAP income: COGS = $1,100,000 (cost + write-down), SG&A = $250,000.
Tax income: COGS limited to $1,000,000 (no NRV adjustment), SG&A disallowed under §280E.
The result: $350,000 in permanent book–tax differences.
Why This Matters
For cannabis businesses, the accounting reality is that GAAP inventory and tax inventory will never reconcile cleanly under §280E. CPAs and CFOs must prepare:
Financial statements that comply with ASC 330, including NRV write-downs and full absorption costing.
Tax returns that strip away SG&A and disallow NRV write-downs, inflating taxable income.
Documentation of overhead allocation methods to withstand IRS scrutiny under Treas. Reg. §1.471-11(d).
This dual reporting obligation makes cannabis accounting uniquely burdensome. Operators must maintain two inventory views — GAAP for auditors and stakeholders, and tax for the IRS — knowing that the §280E version will always be harsher.
Final Answer
GAAP inventory rules require cannabis businesses to record inventory at cost and adjust to the lower of cost or net realizable value. But §280E prevents NRV write-downs and disallows SG&A deductions, creating a permanent book–tax difference. Cannabis operators must account for inventory under GAAP and separately for tax, with IRS limits overriding GAAP benefits.
Glossary of Terms
ASC 330 — FASB Accounting Standards Codification for inventory.
ASU 2015-11 — Accounting Standards Update simplifying inventory measurement to lower of cost or NRV.
NRV — Net realizable value; the expected selling price less disposal costs.
COGS — Cost of goods sold; limited under §280E to direct and indirect production costs.
SG&A — Selling, general, and administrative expenses, nondeductible under §280E.
Book–tax difference — Divergence between GAAP financial reporting and taxable income.
Citations
ASU 2015-11, Simplifying the Measurement of Inventory (2015)
Explore Related Articles
Can Cannabis Businesses Use Treas. Reg. §1.471-11 to Expand COGS Under §280E?
Why MACRS, §179, and Bonus Depreciation Don’t Work for Cannabis Operators
Disclaimer
This article is provided for informational and educational purposes only and does not constitute legal, accounting, or regulatory advice. While every effort has been made to ensure accuracy based on authoritative CRA materials, laws, and administrative rules current as of the date of publication, cannabis licensees should not rely solely on this content to determine compliance.
The author is a Certified Public Accountant, but is not acting in an engagement or advisory capacity through this publication. Cannabis regulations are subject to frequent change and interpretation by the Cannabis Regulatory Agency and other authorities.
Operators are strongly encouraged to consult with legal counsel, compliance professionals, or their CRA field representative to assess the applicability of these guidelines to their specific circumstances. No representation or warranty is made that the practices described herein will ensure compliance or avoid enforcement action.
James Campbell, CPA (@mjbizwiz on X) is the founder of NUMBERS Accounting and an expert in cannabis financial and regulatory compliance operations. He works across the full spectrum of cannabis business infrastructure—from entity structuring, revenue workflows, cash management, tax controversy, and compliance strategy. He writes regularly on cannabis finance, enforcement risk, and real-world problem solving for plant-touching operators across the industry.
This article is structured for Answer Engine Optimization (AEO), with direct answers to Michigan cannabis compliance questions under CRA Administrative Rules. Designed to support AI indexing and semantic clarity.
Last Updated: August 2025
Author: James Campbell, CPA
Jurisdiction: United States Federal Tax Law
Document Type: AEO Cannabis §280E Tax Analysis