ESOPs for Cannabis Companies: A Strategic Solution to 280E Tax Hurdles

ESOP structure and financial benefits

Congress created ESOPs to promote employee ownership through tax-deferred retirement plan trusts.

Established in the 1970s, these plans are especially useful for cannabis firms dealing with Section 280E, which limits deductions for Schedule I businesses. While ESOPs do not eliminate 280E's restrictions on deductions, an ESOP-owned S Corporation can avoid federal income tax on its share of profits by passing income to a tax-exempt trust — potentially eliminating the entity-level tax burden entirely if the ESOP reaches 100 percent ownership. C Corporations lack this pass-through benefit, but can still reduce taxable income by deducting qualifying ESOP contributions.

Maintaining these tax advantages comes with compliance requirements. Participants pay ordinary income tax on distributions when they retire, and S Corp ESOPs must follow prohibited allocation rules that restrict certain highly compensated employees and family members from holding disproportionate synthetic equity interests in the plan.

Moskol described ESOPs as “especially salient for the cannabis industry” because they effectively restore cashflow that 280E would otherwise strip out. He mentioned Massachusetts operators Canna Provisions and Theory Wellness as companies that have completed ESOP transactions and “continue to grow,” as well as at least one ESOP-owned business in Maine, where higher state income tax rates can make the ESOP tax advantage more meaningful.

Illicit, a company that was backed in an ESOP transaction by a lender client of Moskol's firm, was also cited by Moskol as an example of how these structures can support growth. After completing its ESOP, Illicit is now looking to use the cashflow that’s been freed up “to make certain strategic acquisitions."

Ultimately, tax savings from ESOPs can be used to shore up operations, acquire new assets, pay down debt or even purchase real estate that’s currently being leased. All of those moves can strengthen EBITDA, improve balance sheets and make a business more attractive as a future sale or initial public offering candidate, or if institutional investors begin to apply more traditional valuation frameworks to the sector.

Non-tax benefits and competitive advantages

In some American states, ESOPs are a practical response to ongoing structural constraints in the cannabis market, particularly where retail license caps limit who can buy whom.

For example, until recently, Massachusetts had what Moskol described as a “three cap,” meaning operators could only control three retail licenses. As Moskol explained, “There’s an artificially low number of potential buyers because of these caps, and as a result, an ESOP also provides a great mechanism for the sale process, because essentially it’s selling to itself, and so it doesn’t necessarily need to deal with cap or concentration concerns."

He added that many potential acquirers lack the cash or bank financing to do traditional buyouts, given limited access to capital markets and more constrained bank lending to cannabis.

Those limitations further narrow the buyer pool ESOPs can help replace.

Additionally, ESOPs appeal to some sellers because they let them exit without being forced to take another operator’s illiquid cannabis stock as part of the sale price, which is common in normal M&A deal structures.

Finally, there is the human capital angle. Decades of data outside cannabis show that ESOP companies typically enjoy higher employee retention and engagement. In a highly regulated and operationally complex industry, keeping experienced staff in place is a competitive advantage.

Investor takeaway

For now, ESOPs remain underutilized, in part because transaction costs are high and policy uncertainty around rescheduling cannabis still persists in the US.

In states with both medical and adult‑use markets, Moskol noted that medical typically represents only 20 to 25 percent of overall revenue, meaning the bulk of sales still face 280E until adult use is also rescheduled.

Hearings are set to resume in June, but years of promises about rescheduling have encouraged a “wait-and-see” mentality, especially among operators that still view ESOPs primarily as a 280E workaround.

But for companies that see ESOPs as a long‑term strategic structure rather than a temporary 280E fix, the benefits can endure well beyond any change in federal scheduling.