Navigating IRS 280E After Schedule III: A Practical Guide for Cannabis Operators

Internal Revenue Code Section 280E prohibits businesses that traffic in Schedule I or II controlled substances from deducting ordinary business expenses. Following the April 2026 federal order moving state-licensed medical marijuana to Schedule III, qualifying medical operators are no longer subject to 280E — while adult-use businesses, still in Schedule I pending the broader DEA rulemaking, remain fully exposed. For those operators, 280E still means paying federal income tax on gross profit rather than net income.

The one significant carve-out is cost of goods sold. Cannabis businesses may still reduce gross receipts by properly calculated COGS, which makes inventory accounting and cost allocation decisions critically important. Producers and processors generally have more room to allocate costs into COGS than pure retailers do.

Entity structure matters as well. How management companies, real estate holding entities, and operating companies are organized — and how they charge one another — directly affects the 280E exposure of the plant-touching business. These structures must reflect real economic substance; the IRS has successfully challenged arrangements that exist only on paper.

Recordkeeping is where audits are won and lost. The IRS has devoted significant enforcement resources to the cannabis industry, and operators with sloppy books face not only 280E adjustments but accuracy-related penalties. Contemporaneous documentation of inventory, allocations, and intercompany agreements is essential.

Medical operators should approach the transition carefully. Questions about which tax years qualify, how to document that a state license meets the federal order's requirements, and whether to amend prior positions all require careful guidance. Adult-use operators should watch the pending DEA rulemaking on broader rescheduling — if it finalizes, 280E relief would extend to them as well. Businesses with clean books and thoughtful structures will capture relief fastest in either scenario.

280E planning sits at the intersection of tax law, entity structuring, and cannabis regulation. Work with counsel and accountants who understand all three, and revisit your structure annually as the law evolves.