Cannabis wages disallowed under §280E can't boost QBID

Among the many complexities facing cannabis business operators are the tax challenges surrounding owner-level deductions.

Section 280E of the Internal Revenue Code (IRC) provides that business deductions and credits are not allowed for expenses related to trafficking in controlled substances. Because marijuana remains a Schedule I controlled substance under federal law, businesses engaged in its sale are subject to §280E regardless of state legality.

Typical wage and payroll deductions that mainstream businesses rely on, are therefore not available to cannabis businesses. But what about using those wages for an owner-level deduction?

At stake in the recent Savage v. Commissioner, 165 T.C. No. 5 (2025), was the valuable qualified business income deduction (QBID) under §199A. This provision allows owners of pass-through entities, such as partnerships and S corporations, to deduct up to 20% of qualified business income from taxable income. 

The Tax Court made its position clear: wages disallowed under §280E are also excluded from the wage limitation in calculating the QBID.

Case background

The petitioners, Ayla Savage and Patricia Torres, were shareholders in three distinct S corporations. Two of these S-corps operated cannabis businesses and were subject to §280E, while the third S-corp was not.

Like many pass-through business owners, Savage and Torres claimed the §199A deduction for 2018 and 2019. To maximize their benefit, they included all wages reported on Form W-2, Wage and Tax Statement, by the S corporations, even those not deductible after applying §280E. 

The IRS disagreed with this allocation, limiting the QBID calculation to just deductible wages. The result for the two taxpayers was more than $1 million in tax deficiencies and penalties across the two years.

The court's reasoning

After the IRS disallowed portions of the taxpayers’ §199A deduction, the petitioners challenged the adjustments, continuing with their assertion that all S-corps W-2 wages should be included in calculating the QBID.

The court ruled in favor of the IRS, citing that

• §199A(b)(4)(B) requires wages to be properly allocable to qualified business income.
• §199A(c)(3)(A)(ii) limits qualified items of income, gain, deduction and loss to amounts allowed in determining taxable income.
• Because §280E disallows wages tied to cannabis trafficking, those wages can’t be part of qualified business income.
• Therefore cannabis-linked wages don’t count as W-2 wages for the QBID wage cap.

Summary: For §199A purposes, only deductible wages factor in. 

A dissenting view

One judge dissented, reasoning that Congress designed the wage limitation in §199A to encourage job creation. Because cannabis businesses do, in fact, employ workers, he argued that Savage’s and Torres’s total wages should count toward QBID, regardless of §280E’s disallowance.   The dissent also noted the statute's ambiguity, suggesting that in close cases, courts should interpret tax law in favor of the taxpayer.

The majority, however, took a stricter approach, emphasizing that statutory text overrides policy goals. In their view, the law’s plain language left no room to include nondeductible wages in the QBID calculation.

Why Savage v. Commissioner matters for small practitioners

For tax professionals advising cannabis operators, the ruling underscores three critical points:

• Deductibility drives the QBI wage cap. W-2 wages that aren't deductible under §280E don't help clients secure a larger §199A deduction.
• Ripple effects of §280E. The statute not only disallows common business tax deductions but also blocks other indirect tax benefits found throughout the IRC.
• Planning is more important than ever. Practitioners must carefully model different scenarios and analyze whether entity choice or restructuring may help minimize tax exposure.

A quick §280E and §199A illustration

Imagine a cannabis S-corp pays $600,000 in wages. After §280E, only $150,000 is deductible. If the owner reports $1 million in qualified business income:

• If all wages counted: The §199A wage cap would be $300,000 (50% of $600,000). That would easily support the 20% deduction of $200,000.
• With only deductible wages: The cap drops to $75,000 (50% of $150,000), reducing the allowable §199A deduction by more than half.

Practitioner action plan

Here are ways to help cannabis clients adjust their strategies:

• Segregate deductible vs. nondeductible wages. Track wage characterizations clearly in accounting systems so QBI models remain accurate.
• Evaluate entity structure. Some cannabis businesses may benefit from C corporation status despite double taxation, given §280E’s reach.
• Model "what if" scenarios. Run projections comparing QBI results with and without nondeductible wages to show clients the impact.
• Watch federal reform. If cannabis is rescheduled under the Controlled Substances Act, §280E’s restrictions could change, altering the QBI landscape.

Key cannabis-QBID case takeaway

The Savage decision confirms that cannabis operators face tighter restrictions than most pass-through businesses regarding the QBI deduction. Tax professionals should treat nondeductible wages as off-limits for §199A planning and help clients adjust their strategies accordingly.

Want to dig deeper into cannabis tax issues?

• Explore real-world case studies in The Ins and Outs of Cannabis Taxation On-Demand Webinar
• Read more analysis in the TAXPRO library article: Cannabis | Is there an ethical dilemma in providing tax services for this industry? | NATP

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