Running Payroll for Cannabis Businesses: The Complete Compliance Guide for 2026

PayrollBeacon | February 2026 | 12 min read

Cannabis businesses face a compliance nightmare that no other industry experiences: operating legally under state law while remaining federally illegal. This creates a unique set of payroll, tax, and HR challenges that can sink an otherwise successful operation. Here's what you need to know.

Hemp vs. Marijuana: Why the Distinction Matters for Employers

Before diving into compliance, you need to understand a fundamental legal distinction that affects everything from your banking relationships to your tax burden.

	Hemp	Marijuana
Legal Definition	Cannabis with ≤0.3% delta-9 THC	Cannabis with >0.3% delta-9 THC
Federal Status	Legal (2018 Farm Bill)	Schedule I controlled substance*
Section 280E	Does NOT apply	Applies (no business deductions)
Banking Access	Standard access	Severely restricted
Payroll Complexity	Standard	High

*Note: President Trump signed an executive order in December 2025 directing the DEA to reschedule cannabis to Schedule III. Until rescheduling is finalized, marijuana remains Schedule I and Section 280E still applies.

The key takeaway: If you're running a hemp business (CBD products, industrial hemp, etc.) under the 2018 Farm Bill's 0.3% THC threshold, you operate largely like any other agricultural or retail business. If you're operating a marijuana dispensary, cultivation facility, or processing operation, you face an entirely different compliance landscape.

Important 2026 Update: New federal legislation effective November 2026 redefines hemp to restrict total THC (including THCA) to 0.3%, closes the "hemp loophole" for synthetic cannabinoids like Delta-8, and limits final products to 0.4mg THC per container. Hemp-derived THC beverage and edible businesses may be significantly impacted.

The Section 280E Problem: Why Cannabis Payroll Is Different

For marijuana businesses, IRS Code Section 280E is the elephant in the room. Enacted in 1982 to prevent drug dealers from claiming business deductions, it now applies to every state-licensed cannabis operation.

What 280E means for your business:

You cannot deduct ordinary business expenses (rent, utilities, marketing, administrative salaries) from your federal income taxes
You can deduct Cost of Goods Sold (COGS)
Effective tax rates often exceed 50-70% of gross income
Your payroll is NOT deductible unless it's directly tied to production/cultivation

The payroll allocation challenge:

Because of 280E, how you classify and allocate employee labor matters enormously:

Employee Role	280E Treatment	Tax Impact
Cultivator (plant-touching)	COGS - Deductible	Reduces taxable income
Trimmer/Processor	COGS - Deductible	Reduces taxable income
Budtender (sales)	SG&A - NOT deductible	No tax benefit
Store Manager	SG&A - NOT deductible	No tax benefit
Bookkeeper/Admin	SG&A - NOT deductible	No tax benefit
Security	Depends on allocation	Partial benefit possible

What this means in practice: A dispensary paying $500,000 in annual wages might only be able to deduct $150,000 of that (the portion allocated to COGS-eligible activities), while the remaining $350,000 provides zero tax benefit. This is why detailed time tracking by activity is critical.

The Rescheduling Wild Card

If cannabis is rescheduled to Schedule III (expected sometime in 2026), Section 280E would no longer apply to state-licensed cannabis businesses. This would allow deduction of all ordinary business expenses, potentially cutting effective tax rates in half. However, until rescheduling is finalized and effective, you must continue operating under 280E rules.

The Banking Problem: How to Actually Pay Employees

Only about 11% of banks serve cannabis-related businesses. This creates real operational challenges for payroll.

Why banks won't work with cannabis businesses:

Federal money laundering concerns (marijuana proceeds are technically "drug money")
FinCEN reporting requirements (Suspicious Activity Reports for every transaction)
FDIC insurance doesn't cover cannabis transactions
Fear of federal prosecution or regulatory action

Your payroll options:

1. Cash Payments (Risky)

Some dispensaries pay employees in cash out of necessity. This is legal but problematic:

Still must withhold taxes — You're required to withhold federal and state income tax, Social Security, and Medicare regardless of payment method
Documentation nightmare — Must provide pay stubs, maintain signed receipts, keep detailed records
Security risks — Large cash on hand attracts theft
Audit red flag — IRS and state labor departments scrutinize cash-heavy operations
Employee inconvenience — Workers can't direct deposit, may have trouble cashing large amounts

If you must use cash, document everything obsessively: amounts, dates, employee signatures, tax calculations.

2. Cannabis-Friendly Banking Partners

A growing number of credit unions and community banks now serve cannabis businesses:

Maps Credit Union (Oregon)
Partner Colorado Credit Union
Severn Bank (Maryland)
Safe Harbor Financial
Various state-chartered credit unions

These institutions understand FinCEN requirements and can provide checking accounts, ACH transfers, and payroll processing. Expect higher fees and more documentation than traditional banking.

3. Cannabis-Specific Payroll Providers

Several payroll companies specialize in cannabis:

Hybrid Payroll — Full-service with 280E allocation tools
Panacea Payroll — Cannabis-focused with cash handling features
Greenleaf HR — Payroll + HR + compliance
Wurk — Enterprise-level cannabis HCM

These providers have banking relationships already established and understand industry-specific compliance requirements.

4. Payroll Cards

Reloadable prepaid cards offer a middle ground between cash and traditional direct deposit. Employees can access funds at ATMs or use cards for purchases. Verify that your card provider complies with state labor laws regarding fund access.

Federal Payroll Tax Obligations (Yes, They Still Apply)

Despite federal illegality, cannabis businesses must pay all federal employment taxes. The IRS will happily take your money.

Required federal payroll taxes:

Tax	Rate	Employer Responsibility
Social Security (FICA)	6.2%	Withhold from employee + match
Medicare	1.45%	Withhold from employee + match
Additional Medicare	0.9%	Withhold on wages over $200K
Federal Unemployment (FUTA)	6% on first $7,000	Employer pays
Federal Income Tax	Varies	Withhold based on W-4

Key compliance points:

File Form 941 quarterly
Deposit taxes on time (failure-to-deposit penalties are steep)
Issue W-2s by January 31
Report cash transactions over $10,000 on Form 8300

The ERC Trap: A recent Court of Federal Claims decision (Gravenstein 116, LLC v. United States, January 2026) confirmed that cannabis businesses cannot claim the Employee Retention Credit due to Section 280E's prohibition on credits. Don't try it.

State-Specific Cannabis Employment Requirements

Beyond federal requirements, most states with legal cannabis have industry-specific employment rules.

Licensing and Worker Permits

Many states require cannabis employees to obtain individual permits or badges:

State	Requirement	Processing Time	Renewal
Colorado	Occupational License (MED)	2-4 weeks	Every 2 years
Oregon	Marijuana Worker Permit (OLCC)	1-2 weeks	Every 5 years
Montana	Marijuana Worker Permit	2-3 weeks	Annual
California	Employee Registration	Varies by local jurisdiction	Varies
Michigan	Employee License	4-6 weeks	Annual

Compliance tip: Build permit processing time into your hiring timeline. You cannot legally allow an employee to work with cannabis products until their permit is approved.

Background Check Requirements

Most state cannabis regulators require background checks for all employees. Common disqualifiers include:

Recent felony convictions (lookback periods vary by state)
Drug trafficking convictions
Certain violent offenses
Financial crimes

Some states have "ban the box" laws that limit when you can ask about criminal history, even for cannabis positions. Know your state's rules.

Overlapping Employment Restrictions

Some states prohibit employees from working for multiple cannabis license types simultaneously. For example, in Michigan, an individual cannot be employed by both a retail dispensary and a testing laboratory at the same time.

Labor Peace Agreements

Several states (California, New York, New Jersey, others) require cannabis employers to enter into labor peace agreements with unions as a condition of licensing. These agreements typically require employers to remain neutral during union organizing and may include other provisions. Consult a labor attorney before signing.

Employee Drug Testing: The Irony

Here's the paradox: you can employ people to sell cannabis, but in many states, you can still fire them for using it.

The evolving landscape:

States are increasingly protecting employees' off-duty cannabis use:

California: Cannot discriminate based on off-duty use or positive tests for non-psychoactive metabolites (exceptions for construction trades, federal positions)
New York: Cannot test for cannabis except in limited circumstances
Nevada: Cannot deny employment based on pre-employment cannabis test
Washington: Similar protections for off-duty use

However, you generally CAN still:

Prohibit on-the-job impairment
Maintain drug-free workplace policies for safety-sensitive positions
Test employees in DOT-regulated positions
Take action for on-duty impairment

Practical guidance:

Review your state's specific employment protections for cannabis users
Update drug testing policies to focus on impairment, not mere presence of metabolites
Train managers on identifying impairment vs. off-duty use
Document everything if taking adverse action

Record-Keeping Requirements

Cannabis businesses face heightened scrutiny from multiple regulators. Meticulous record-keeping is essential.

Payroll records to maintain:

Employee names, addresses, Social Security numbers
Dates hired and terminated
Hours worked (detailed by activity for 280E allocation)
Pay rates and calculation methods
Gross wages and all deductions
Tax withholdings and deposits
Signed acknowledgment of cash payments (if applicable)

Retention periods:

FLSA requires 3 years for payroll records
State requirements may be longer
280E audit exposure means keeping records indefinitely is wise
State cannabis regulators often require records for license term + additional years

Time tracking best practices:

For 280E compliance, track employee time by specific activity category:

Cultivation/production (COGS-eligible)
Processing/packaging (COGS-eligible)
Sales/retail (not deductible)
Administrative (not deductible)
Security (allocate based on duties)

This granular tracking supports your tax position if audited.

Common Compliance Mistakes

1. Misclassifying employees as independent contractors

The IRS and state labor departments are watching. Cannabis businesses are targets. If you control when, where, and how someone works, they're probably an employee.

2. Failing to allocate labor costs for 280E

If you're not tracking which wages are COGS-eligible, you're likely overpaying taxes.

3. Using a mainstream payroll provider that drops you

Major payroll companies (ADP, Paychex, Gusto) have been known to terminate cannabis clients with little notice. Use a cannabis-specific provider.

4. Ignoring state cannabis employment regulations

Worker permits, background checks, training requirements — missing these can cost you your license.

5. Not documenting cash payments properly

If you pay in cash, you still need pay stubs, signed receipts, and detailed records.

6. Assuming rescheduling has already happened

Until the DEA finalizes rescheduling, operate under current 280E rules.

Compliance Checklist for Cannabis Employers

Before You Hire

Verify position requires cannabis worker permit (if applicable)
Build permit processing time into hiring timeline
Conduct required background check
Confirm no overlapping employment restrictions
Check state employee protection laws re: cannabis use

Payroll Setup

Establish cannabis-friendly banking relationship
Select cannabis-specific payroll provider
Set up time tracking by activity category (for 280E)
Register for state unemployment insurance
Obtain workers' compensation coverage

Ongoing Compliance

Withhold and deposit federal/state payroll taxes on time
File quarterly 941 and state returns
Allocate wages between COGS and SG&A for 280E
Maintain detailed records of all compensation
Issue W-2s by January 31
Monitor for changes in state cannabis employment laws
Track permit renewals for all employees

The Bottom Line

Running payroll for a cannabis business requires navigating a minefield of federal-state conflicts, banking restrictions, and industry-specific regulations. The good news: it's entirely manageable with the right partners and systems in place.

Key takeaways:

Hemp businesses (≤0.3% THC) operate largely like normal businesses; marijuana businesses face 280E and banking challenges
Section 280E makes labor cost allocation critical — track time by activity
Use cannabis-specific banking and payroll providers
Stay current on your state's worker permit and employment protection laws
Document everything obsessively
Watch for rescheduling developments, but don't count your deductions before they're legal

Disclaimer: This article is for informational purposes only and does not constitute legal, tax, or accounting advice. Cannabis compliance is complex and changes rapidly. Consult with qualified professionals before making business decisions.

Sources:

IRS Code Section 280E
2018 Agriculture Improvement Act (Farm Bill)
FinCEN Guidance on Cannabis Banking (FIN-2014-G001)
Gravenstein 116, LLC v. United States (Court of Federal Claims, January 2026)
State cannabis regulatory agencies
NCSL Cannabis and Employment Policy Database