On April 28, 2026, marijuana held under a state medical marijuana license moved from Schedule I to Schedule III of the Controlled Substances Act. Section 280E of the Internal Revenue Code only applies to Schedule I and Schedule II substances. Accordingly, the deduction ban related to medical marijuana businesses no longer applies.
Recreational marijuana is still considered a Schedule I controlled substance, so the deduction ban applies. Many cannabis businesses hold licenses for both recreational and medicinal marijuana, adding additional tax complexity for such businesses. This page covers what changed, what did not, and what an examiner will ask for.
Section 280E denies every deduction and every credit attributable to a trade or business that traffics in a Schedule I or Schedule II controlled substance. The statute reads:
No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
Outside cost of goods sold, rent, payroll, marketing, insurance, professional fees, and interest are all disallowed. So are credits for research, energy efficiency, and hiring. The business is taxed on something close to gross profit while an ordinary business is taxed on net income, so a cannabis business can owe federal income tax even in a year it loses money.
Congress enacted 280E in 1982 as part of Public Law 97-248, twelve years after the Controlled Substances Act placed marijuana in Schedule I. Read the current text at 26 U.S.C. § 280E.
It ended 280E for some cannabis businesses and left it fully in place for others. The DEA final rule published at 91 FR 22714 on April 28, 2026, moved three categories to Schedule III and left everything else in Schedule I.
| Category | Schedule after April 28, 2026 | Does 280E reach it? |
|---|---|---|
| FDA-approved drug products containing marijuana | Schedule III | No |
| Marijuana subject to a state medical marijuana license | Schedule III | No |
| Marijuana extracts and naturally derived delta-9 THC within those two categories | Schedule III | No |
| Adult-use (recreational) marijuana | Schedule I | Yes |
| Unlicensed bulk marijuana, extracts, and delta-9 THC | Schedule I | Yes |
| Synthetically derived THC, such as delta-10 | Schedule I | Yes |
On scheduling, the DEA rule leaves no room for interpretation: “Any form of marijuana other than in an FDA-approved drug product or marijuana subject to a state medical marijuana license remains a schedule I controlled substance.” On taxes, it is more careful. The rule says “state licensees will no longer be subject to the deduction disallowance imposed by Section 280E,” then adds that “Nothing in this rule constitutes a determination regarding federal tax liability.” The DEA described the tax effect and left the tax determination to Treasury and the IRS. The full text is on the Federal Register.
280E was not amended or repealed. What changed is which substances it reaches. The order also faces a legal challenge. On September 9, 2026, the U.S. Court of Appeals for the D.C. Circuit declined to pause it while consolidated petitions for review proceed. The order remains in effect while the court considers the merits.
It depends on whether the sale occurred under a recreational or medicinal license. Both licensing statutes use the older spelling “marihuana,” which appears below only in their official names.
Marijuana handled under licenses issued under the Medical Marihuana Facilities Licensing Act, including provisioning center, grower, and processor licenses, falls in the Schedule III category as of April 28, 2026. Under the transition rule Treasury previewed, relief would generally apply for the business’s full taxable year that includes that date.
Licenses issued under your state’s recreational marijuana act, such as the Michigan Regulation and Taxation of Marihuana Act, including retailer, grower, processor, and microbusiness licenses, cover recreational marijuana, which stayed in Schedule I. Those activities remain subject to 280E.
You are running a Schedule III business and a Schedule I business under one roof, and you have to separate them.
Treasury said the coming guidance will clarify “the ways in which, for businesses with multiple activities, Section 280E applies only to those activities related to trafficking in Schedule I or II controlled substances (e.g., by apportioning expenses).” Until that guidance is issued, there is no published method for the split.
No. As of October 2026, Treasury and the IRS published no Notice, Revenue Procedure, Revenue Ruling, or regulation implementing post-rescheduling 280E relief.
Treasury announced on April 23, 2026, that it would issue guidance. It previewed a transition rule under which rescheduling “generally will be considered to first apply for a business’s full taxable year that includes the effective date of the Final Order, for the business’s activities that do not involve Schedule I or II controlled substances.” That language is written in the future tense. It announces a rule that does not exist yet. The Treasury release is the primary source. The 2026-2027 Priority Guidance Plan, released September 29, 2026, lists “Guidance under §280E” as an open project under Other Priorities. The plan states that it “does not provide any deadline for completing the projects.”
Meanwhile, the IRS cannabis industry page, last reviewed February 6, 2026, still states the pre-rescheduling rule without qualification. Anyone taking a return position on the strength of the April announcement is taking it without agency guidance behind it.
The IRS audits a cannabis business like any cash-intensive business, using indirect income reconstruction methods and closely examining inventory records. For a Schedule I operator, 280E already settles whether rent is deductible. The question an examiner tests is whether your cost of goods sold allocation holds up.
The Treasury Inspector General for Tax Administration examined this in Report No. 2020-30-017, issued March 30, 2020. Reviewing random samples of marijuana business returns from California, Oregon, and Washington for Tax Year 2016, TIGTA found likely 280E adjustments in 59% of them, 140 of 237.
In the IRS Western Area in fiscal year 2018, marijuana examinations produced $82,831 to $172,737 per return, against $36,658 per return for standard discriminant-function examinations. Those figures measure what examiners find once they look. They say nothing about how often an examination opens, which makes them the better numbers to plan against.
Cash-intensive operations draw scrutiny on their own, and the pattern that escalates it is familiar: losses that persist in a business that looks successful, bank balances climbing while reported profit stays flat, a standard of living the return cannot support, and sales that stay implausibly low. The full taxonomy is on our page covering common IRS audit red flags.
Cannabis operators can also draw attention from the IRS Special Enforcement Program, the unit whose civil examinations can develop into criminal referrals.
Examiners must complete a minimum income probe on every return they examine, with limited exceptions, and we cover that probe in detail in how the IRS audits income for cash businesses. They compare the return with prior years, its own supporting schedules, and similar businesses. They test the reliability of the taxpayer’s books and flag large, unusual, or questionable items. When the books cannot support the return, examiners stop relying on them and reconstruct income with a formal indirect method, such as bank deposits and cash expenditures, markup, or net worth.
If your records are incomplete, the Cohan rule and the IRS retention guidance are explained on our page about being audited without receipts.
Contemporaneous records that let an examiner trace a cost from the original invoice through your allocation method to its treatment as cost of goods sold or as a disallowed expense. In practice, that means measured floor plans showing production versus non-production square footage, utility consumption records (sub-metered where possible), signed time records showing which employees worked on production, equipment usage logs, direct material invoices, payroll broken out by function, and seed-to-sale batch records. Records reconstructed at year-end are harder to substantiate in an examination.
The IRS also reminds businesses that receive cash that any person in a trade or business who receives more than $10,000 in cash in a single transaction or in related transactions must file Form 8300 within 15 days of receiving payment. For the general preparation sequence once a notice arrives, see how to prepare for an IRS audit, and for how long the IRS has to open the year, see our page on the statute of limitations for IRS audits.
For recreational activity, and for medical activity in years before rescheduling, the answer is cost of goods sold and nothing else. 280E bars deductions and credits. Cost of goods sold is not a deduction. It is subtracted from gross receipts to arrive at gross income.
The IRS confirmed this in a June 2024 news release on Section 280E: “Section 280E does not, however, prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income.”
How much lands in cost of goods sold is the entire tax question for a Schedule I operator, and it turns on 26 U.S.C. § 471 and the inventory regulations as they stood in 1982. A business that gets this wrong pays unnecessary taxes.
Resellers capture far less. A dispensary buying finished product is a reseller under Treas. Reg. § 1.471-3(b) and capitalizes the invoice price plus the charges incurred in acquiring possession.
A grower or processor is a producer under Treas. Reg. §§ 1.471-3(c) and 1.471-11 and capitalizes direct materials, direct labor, and a defined set of indirect production costs.
| Cost | Reseller (dispensary buying finished product) | Producer (grower or processor) |
|---|---|---|
| Invoice price of product purchased, less trade discounts | In cost of goods sold | Not applicable |
| Transportation and other charges to acquire possession | In cost of goods sold | In cost of goods sold where incurred |
| Seeds, plants, nutrients, growing media | Not applicable | Direct materials, in cost of goods sold |
| Planting, cultivating, harvesting, sorting labor | Not applicable | Direct labor, in cost of goods sold |
| Repairs, maintenance, utilities, rent, indirect production supervision on production space | Disallowed | Category 1 indirect costs under Treas. Reg. 1.471-11(c)(2)(i), in cost of goods sold |
| Advertising, marketing, selling expense | Disallowed | Disallowed |
| Retail rent, retail staff wages, general and administrative salaries | Disallowed | Disallowed |
| Professional fees, insurance, interest | Disallowed | Disallowed |
That split follows Chief Counsel Advice 201504011, dated December 10, 2014 and released January 23, 2015. Its stated conclusion reads, “A taxpayer trafficking in a Schedule I or Schedule II controlled substance determines COGS using the applicable inventory-costing regulations under §471 as they existed when §280E was enacted.”
The memorandum also rejects using Section 263A to capitalize costs 280E disallows, because Section 263A(a)(2) bars capitalizing a cost that could not otherwise be taken into account in computing taxable income.
One caution on authority. Chief Counsel Advice states on its face that it “may not be used or cited as precedent.” The binding law here is Section 471, the regulations, and the case law. The memorandum tells you how the IRS will argue the point, which matters in an examination.
Every constitutional challenge to 280E through October 2026 failed, and no court held the statute unconstitutional. Taxpayers won on a narrower point in CHAMP, where a genuinely separate business kept its deductions. Below are the tax court decisions that shape how 280E is applied:
| Case | Citation | Holding |
|---|---|---|
| Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner | 128 T.C. 173 (2007) | 280E bars deductions for the marijuana business, but a genuinely separate trade or business carried on by the same taxpayer keeps its deductions. |
| Olive v. Commissioner | 139 T.C. 19 (2012), aff’d, 792 F.3d 1146 (9th Cir. 2015) | Free amenities offered alongside marijuana sales are not a separate business. That Congress did not foresee state-legal dispensaries does not limit the statute. |
| Alterman v. Commissioner | T.C. Memo. 2018-83 | Selling paraphernalia alongside marijuana was one unitary business. Inadequate inventory records defeated the cost of goods sold claim and supported accuracy-related penalties. |
| Patients Mutual Assistance Collective Corp. v. Commissioner | 151 T.C. 176 (2018), aff’d, 995 F.3d 671 (9th Cir. 2021) | A dispensary was engaged in one trade or business and had to compute cost of goods sold under the Section 471 reseller rules. |
| Patients Mutual Assistance Collective Corp. v. Commissioner | T.C. Memo. 2024-98 | Rejected both the Sixteenth Amendment direct-tax challenge and the Eighth Amendment excessive-fines challenge to 280E. |
No. The IRS rejected refund claims in this area before. In its June 28, 2024 release, issued while marijuana remained in Schedule I, it said of 280E refund claims filed on amended returns that “these claims are not valid.” The DEA rule encourages Treasury to consider retrospective relief for state licensees, but no such relief exists yet. A timely, properly prepared protective claim can preserve a year while the issue is unresolved. It does not win the argument.
The rescheduling of medical marijuana eases the tax burden on medical marijuana businesses, but adds complexity for cannabis businesses operating under a medical and a recreational license.
Ayar Law represents cannabis businesses in IRS examinations, appeals, and criminal tax matters. Call (248) 262-3400 or request a case review to discuss your position.
This page is general information about federal and Michigan tax law as of October 2026. It is not legal or tax advice, and reading it does not create an attorney-client relationship. Tax results depend on the facts of your business, your license types, and your tax year. Consult a qualified attorney about your own situation.
