For cannabis businesses in the U.S., profitability doesn’t come easy. Operators must navigate a complex landscape of tax regulations, cash flow challenges, and razor-thin margins—all while remaining compliant with federal and state laws. One of the most crucial (yet often misunderstood) areas is how to track Cost of Goods Sold (COGS) in a cannabis business.
If you’re not tracking your COGS accurately, you could be overpaying taxes, underpricing products, or worse—exposing your operation to audits and penalties. In this article, we’ll walk you through what COGS means for cannabis operators, why it’s essential for 280E tax compliance, and how to get it right.
What is COGS and Why Does it Matter in Cannabis?
Cost of Goods Sold (COGS) represents the direct costs of producing the goods your business sells—think raw materials, labor directly involved in production, and certain overhead costs. For cannabis operators, COGS is more than an accounting metric. It’s your lifeline to surviving the IRS’s harsh 280E restrictions.
Under IRS Section 280E, cannabis businesses cannot deduct most typical business expenses due to the plant’s federal classification as a Schedule I drug. The one exception? COGS. This means your ability to track and allocate costs accurately can dramatically affect your tax liability and net profit.
Cannabis-Specific Costs That May Qualify as COGS:
- Direct labor (trimming, packaging, manufacturing)
- Raw materials (soil, seeds, nutrients)
- Rent and utilities for the production facility
- Equipment maintenance and depreciation
- Packaging directly tied to products
- Inventory storage and processing
Pro tip: Retail and dispensary-level expenses like marketing, admin salaries, and sales team commissions typically do not qualify under COGS for 280E purposes.
The 3 Core Steps to Tracking COGS in Your Cannabis Operation
1. Set Up a Cannabis-Specific Chart of Accounts
Start by customizing your accounting system to reflect the nuances of your cannabis business. A tailored chart of accounts (COA) ensures you can isolate COGS-related expenses from non-deductible operating costs.
Key Accounts to Include:
- Cultivation Materials
- Direct Labor – Grow
- Manufacturing Overhead
- Facility Utilities
- Inventory Write-Downs
- Packaging Supplies
Use cannabis-specific accounting software such as QuickBooks with integrations (e.g., Fishbowl, BioTrack, METRC) and PowerBI to improve data accuracy.
2. Maintain Accurate Inventory Tracking
Proper inventory management is the backbone of COGS calculation. Whether you’re growing flower, manufacturing extracts, or running a vertically integrated operation, your inventory tracking must be detailed, real-time, and traceable.
You should:
- Track all inbound and outbound inventory in sync with METRC or other state compliance systems
- Use perpetual inventory methods to match actual usage
- Assign values using FIFO (First In, First Out) for cost consistency
- Implement cycle counts and physical inventory audits to spot discrepancies
Cannabis inventory issues are one of the top triggers for IRS audits.
3. Allocate Costs According to Entity Type
Not all cannabis businesses track COGS the same way. The IRS recognizes different cost allocation rules depending on whether you’re a producer, reseller, or both. Here’s how it breaks down:
For Cultivators and Manufacturers (Producers):
You may include both direct and indirect production costs in COGS, such as:
- Labor and supervision
- Repairs and maintenance
- Utilities and rent
- Depreciation of production equipment
For Dispensaries and Retailers (Resellers):
You’re more limited and typically can only include:
- The purchase price of inventory
- Transportation and storage costs
Tip: Vertically integrated businesses need a hybrid strategy that splits COGS based on operational activity across segments.
Advanced Strategies to Improve COGS Tracking
As your cannabis operation grows, so does the complexity of your financials. These advanced tactics can sharpen your COGS reporting and boost profitability:
Standard Costing
Create cost benchmarks per product unit. This reduces variance and simplifies monthly financial analysis.
Activity-Based Costing (ABC)
Allocate indirect costs (like facility rent or electricity) based on actual usage across cultivation rooms or product lines.
Cost Segregation Studies
For owners of production facilities, this strategy accelerates depreciation on certain assets—lowering taxable income and improving COGS allocation.
Outsourced CFO Services
Partnering with a cannabis-focused CPA firm can be a game-changer for your COGS strategy. Not only can they help you develop a defensible methodology for cost allocation, but they’ll also ensure your financial records are audit-ready and aligned with IRS expectations. From fine-tuning your inventory valuation to preparing compliant documentation, a seasoned cannabis CPA helps reduce risk, maximize deductions, and keep your operation on solid financial ground.
Common Mistakes to Avoid
Even experienced operators can get COGS wrong. Here are common pitfalls to watch out for:
- Lumping all expenses together without separating production from administrative costs
- Failing to reconcile inventory regularly or using inaccurate counts
- Not adapting COGS tracking as you scale or add new product lines
- Overstating deductions and increasing audit risk
The best protection? A meticulous accounting process and a CPA that knows the cannabis industry inside and out.
FAQs: Cannabis COGS Tracking
What does COGS stand for in cannabis?
COGS stands for Cost of Goods Sold, which includes all direct costs involved in producing your cannabis products.
Why is COGS important for cannabis businesses?
It’s the only deductible category under IRS 280E, so properly tracking it reduces your tax burden and helps you stay compliant.
What expenses qualify for COGS in cannabis?
Direct labor, raw materials, production-related utilities, rent for grow facilities, packaging tied to production, and some equipment depreciation.
Can dispensaries deduct COGS?
Yes, but their deductions are limited to the cost of purchasing inventory and storing it—no marketing or overhead costs are included.
How can I improve my COGS tracking?
Use cannabis-specific accounting tools, implement real-time inventory systems, and partner with a CPA who understands industry nuances.
Final Thoughts
Tracking COGS isn’t just a back-office task—it’s a critical driver of profitability and compliance in your cannabis business. As regulations evolve and margins tighten, your ability to allocate costs correctly could mean the difference between thriving and barely surviving.
That’s where we come in.
GreenGrowth CPAs has helped hundreds of cannabis operators across the U.S. improve their financial systems, optimize for 280E, and boost profitability through strategic COGS planning.
📢 Need expert tax guidance for your cannabis business? Schedule a free consultation with GreenGrowth CPAs today and maximize your savings.
