Cannabis Taxation: C Corp, S Corp, LLC, LLP, Partnership, Nonprofit, or Something Else for Your Cannabis Business?

Choosing the Right Business Entity in the Cannabis Industry

One of the most fundamental questions facing any entrepreneur – whether in the cannabis industry or elsewhere – is:

“What type of business entity should I choose?”

This is a deceptively complex question, although we’ll try to make it seem simple here.  When you ask your lawyer or accountant, their first response will likely be “it depends,” and that’s because it does in fact depend.  They’ll follow up with a series of at least ten follow-up questions designed to uncover your goals, your business model, your partners’ expectations, and the nature of your financing. Some of these questions are tax-related, others are regulatory, and still others revolve around investor relationships, control, or operational flexibility.

First, though, let’s address a foundational question many new entrepreneurs ask:

“Is it really necessary to form a business entity?”

The short answer is yes. A properly formed and maintained business entity is quite literally what puts the “limited” in “limited liability company.”  These entities, whether LLCs, corporations or others, help shield your personal assets from the liabilities of your business(es). But liability protection doesn’t stop there—you also need proper insurance coverage and capitalization, in addition to well-drafted contracts. These are essential tools for managing risk and sleeping well at night.

Some industries are relatively low-risk (spoiler: cannabis is not one of them). Some entrepreneurs may be “judgment-proof” (meaning they have few personal assets at risk), but that’s not usually the case when launching a serious business. And some business owners like to operate without legal or financial safety nets—but they rarely last long. The bottom line is this: forming a business entity is an inexpensive and vital foundation for building a strong, credible company.  Don’t skip this step.

Let’s walk through some of the key questions that will shape your entity selection:

Tax-Related Questions

• Do you or your co-owners need to offset income from other businesses?
• Are you looking to maximize losses in this venture? (e.g., Will you own 50% of the business, but your partner wants to claim 100% of the early losses?)
• Are any owners non-U.S. residents?
• If taxed as a pass-through entity, are you and your partners prepared to pay taxes on profits—even if the business reinvests most of its income?
• Will your business involve owning real estate or significant intellectual property?
• Will the business hold assets expected to appreciate?
• What is the anticipated impact of IRC §280E on your business model?  If you are or intend to become a licensed cannabis entity, §280E will likely apply.

Regulatory Questions

• Do your state’s cannabis laws mandate a specific type of entity? (e.g., Some states require licensees to be nonprofits or to operate on a not-for-profit basis.)
• Do the regulations require full ownership transparency?
• Would it be advantageous to keep certain owners out of the public eye, if regulations allow?

Mission and Purpose Questions

• Are you launching the business with a specific mission that could attract mission-aligned investors?
• Will your business aim to deliver social good—such as through education, charitable work, or filling gaps in public services?

Financing-Related Questions

• Do you plan to raise money from outside investors, such as private equity or venture capital? If so, have they indicated a preference for a particular entity type?
• Will all owners share equally in profits, or will you have different classes of ownership (e.g., preferred vs. common, voting vs. non-voting)?
• How many owners do you anticipate within the first five years?
• Will any owners be corporations (C corps or S corps)?
• Do you plan to take the company public, once legally and commercially feasible?
• How will funds flow from the business to its owners—salary, distributions, debt repayments, or a mix?

Control and Flexibility Questions

• Will you have a small, tight-knit ownership group or a larger, more complex one?
• Will all owners share equal rights in profits and decision-making about distributions?
• Are you part of a minority or majority owner group?
• What governance structure do you envision? (e.g., Member-managed vs. manager-managed, board oversight, etc.)
• Do you intend to bring in outside management?

Your answers to these and other questions will guide your legal and tax advisors in helping you choose the best business entity and structure. For example, just because you’re using an LLC doesn’t mean you can’t elect to be taxed as an S or C corporation. You just need to understand the implications, make the election in a timely manner, and coordinate closely with your attorney and accountant.

Key Considerations for Cannabis Businesses

Choosing a business entity isn’t just a legal formality—it affects everything from how you pay taxes to how you raise money and protect your assets. In the cannabis space, these issues are even more critical due to:

• IRC §280E: Cannabis businesses can’t deduct many ordinary expenses due to federal illegality, making tax planning more complex and magnifying the risk that owners could have tax liabilities, but no income (phantom income taxation).
• State-specific licensing requirements: Some states restrict or mandate certain entity types, or have different disclosure obligations depending on the entity type.
• Investor expectations: Institutional investors sometimes demand C corp structures for equity deals.
• Exit strategies: Your entity type can affect whether and how you can sell the business or go public.

Now let’s look at the actual entity types you can choose from, along with their pros and cons in this highly regulated and risk-intensive industry.  Below is a breakdown of the most commonly used business structures, how they function, and how they align—or conflict—with cannabis business needs.

1. Sole Proprietorship

Summary: This is the default business structure for anyone doing business without forming a legal entity. It is not a separate legal entity from the individual owner.

Pros:

• Simple and inexpensive to start
• No separate tax filing required; income reported on the owner’s personal tax return

Cons:

• No liability protection—personal assets are fully exposed
• Harder to raise capital or gain credibility
• Not suited for regulated industries like cannabis

Bottom Line: Not advisable for cannabis businesses, which face high liability and regulatory risks.

2. General Partnership

Summary: Two or more people conducting business together without forming a separate entity.

Pros:

• Simple setup
• Pass-through taxation (income and losses flow to partners)

Cons:

• Unlimited personal liability for all partners
• Potential for disputes due to shared control
• Not ideal for cannabis businesses with external investors or regulatory burdens

Bottom Line: Like sole proprietorships, general partnerships lack liability protection and structure—making them generally unsuitable for cannabis ventures.

3. Limited Liability Company (LLC)

Summary: A flexible, hybrid entity that offers liability protection with pass-through taxation by default.

Pros:

• Liability protection for owners (called “members”)
• Pass-through taxation (or can elect to be taxed as an S corp or C corp)
• Flexible governance and ownership structure

Cons:

• Some states have restrictions or additional requirements for cannabis-related LLCs
• Can be more complex to manage than a sole proprietorship
• Tax complexity increases with multiple members or election changes
• Without a corporate tax election, owners are not shielded from potential phantom income taxes, a notable risk for businesses to which IRC §280E applies

Bottom Line: LLCs are a top choice for cannabis operators due to their flexibility, liability protection, and compatibility with both simple and complex ownership structures.  However, they can leave the owners exposed to unexpected tax bills, and this problem is especially acute in the cannabis industry thanks to IRC §280E.  Cannabis businesses should use LLCs cautiously.

4. S Corporation

Summary: A corporation that elects pass-through taxation under Subchapter S of the Internal Revenue Code.

Pros:

• Pass-through taxation (no double taxation)
• Liability protection
• Potential payroll tax savings for owner-employees

Cons:

• Ownership restrictions: must have 100 or fewer shareholders, all of whom must be U.S. citizens or residents, and cannot include other corporations or partnerships
• Can only issue one class of stock (limits flexibility for raising capital)
• Some cannabis-related businesses may be disqualified from S corp status depending on federal and state restrictions
• No protection against phantom income taxes thanks to IRC §280E

Bottom Line: Can be useful in smaller cannabis operations with simple ownership and limited capital needs, but often too restrictive for multi-owner or investor-driven models.  Like LLCs, they can leave the owners exposed to unexpected tax bills thanks to IRC §280E, and should be used cautiously.

5. C Corporation

Summary: A standard corporation taxed separately from its owners.

Pros:

• No ownership restrictions—can have unlimited shareholders, including other entities and foreign investors
• Attractive to venture capital and institutional investors
• Ability to issue multiple classes of stock
• Greater reinvestment potential (profits retained in the business without immediate tax to shareholders)
• Traps all potential tax liability within the corporation itself instead of passing liabilities through to its owners – no unexpected tax bills for owners thanks to §280E.

Cons:

• Double taxation (corporate income is taxed, and dividends to shareholders are taxed again); tends to be the highest tax option overall
• Higher compliance costs and formalities

Bottom Line: Best suited for cannabis businesses that plan to scale quickly, raise significant capital, or eventually go public.  Also well-suited for cannabis businesses that might have a sizeable number of non-deductible expenses under §280E and/or want to avoid any unexpected tax bills for their owners.

6. Nonprofit Corporation

Summary: A mission-driven entity that reinvests profits, if any, to further its stated purpose rather than distributing them to owners.

Pros:

• Required structure in some states for medical cannabis collectives or cooperatives
• Potential community goodwill and grant eligibility

Cons:

• Cannot distribute profits to members or shareholders
• Complex compliance and operational restrictions
• Not compatible with most for-profit cannabis business models

Bottom Line: Only appropriate in very narrow circumstances, such as state-mandated medical cannabis collectives. Not a fit for most modern cannabis businesses.

Final Thoughts

There’s no one-size-fits-all solution. An LLC taxed as a partnership may be perfect for a small, family-run dispensary, while a C corporation may be the best choice for a multi-state operator planning to go public. You can often change your tax election or convert your entity later, but doing so requires careful planning and timing.

That’s why it’s essential to work closely with legal and tax professionals who understand the cannabis industry and your long-term goals.

Have questions about how to structure your cannabis business or ready to form an entity? Reach out—we’re here to help.

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