Marijuana Business Tax Compliance: Section 280E and What Rescheduling Changes

March 13, 2026

By: Wiss Team

Wiss Team

Key Takeaways

Section 280E of the Internal Revenue Code prohibits state-legal marijuana businesses from deducting ordinary and necessary business expenses at the federal level because marijuana remains a Schedule I controlled substance — creating effective federal tax rates that, in documented cases, have reached as high as 80%.
Cost of goods sold (COGS) remains deductible even under 280E. This is the single most important tax planning lever available to cannabis businesses operating under current law.
On December 18, 2025, President Trump signed Executive Order 14370, directing the U.S. Attorney General to complete DEA rulemaking to move marijuana from Schedule I to Schedule III in the most expeditious manner permitted by law. As of February 2026, rescheduling has not yet taken effect — the administrative process remains ongoing.
If and when rescheduling is finalized, Section 280E would no longer apply to marijuana businesses. Cannabis operators would gain access to standard business expense deductions, potentially saving the industry an estimated $2.3 billion annually in federal taxes.
Structural decisions made under 280E may not be optimal in a post-280E world. Cannabis businesses should be reviewing their entity elections, cost allocation methods, and operational structures now — before rescheduling takes effect.
Bottom line: This is the most consequential tax policy shift for cannabis operators since 280E was enacted in 1982. Waiting to plan is not a strategy.

There is no other legal industry in the United States that operates under a federal tax structure quite like state-legal marijuana. You can run a profitable, fully compliant business — licensed by your state, paying your employees, filing your returns — and still owe federal income tax on revenue that, after real operating expenses, you lost money on.

That is not hyperbole. That is Section 280E.

Understanding exactly how it works, what it allows, and what may be changing is not optional for cannabis business owners. It is the difference between a viable business and one quietly bleeding out through its tax line.

What Section 280E Actually Says

Section 280E of the Internal Revenue Code was enacted in 1982. It states, with precise economy, that no deduction or credit shall be allowed for amounts paid in carrying on a trade or business that consists of trafficking in controlled substances in Schedule I or II of the Controlled Substances Act.

That language was originally aimed at drug traffickers — written in response to a 1981 U.S. Tax Court decision that allowed an illegal cocaine dealer to deduct his business expenses, including his scale and bags. Congress closed that loophole immediately.

The problem, which Congress did not anticipate in 1982, is that 40 states and the District of Columbia have since legalized medical marijuana, and 24 states plus D.C. have legalized recreational use. The businesses serving those markets are legal under state law. They are not, however, exempt from Section 280E, because marijuana remains a Schedule I controlled substance at the federal level.

The practical consequence is this: where a standard business pays federal income tax on its net income after deductions, a marijuana business pays federal income tax on its gross income — the revenue figure before most expenses are subtracted.

The University of Colorado’s Professor Sloan Speck, who studies how tax rules shape business behavior, put a precise number on the impact: consider a business with $100,000 in revenue and $80,000 in expenses. A standard business pays $4,200 in tax on $20,000 of net income at a 21% corporate rate. The marijuana equivalent — unable to deduct those $80,000 in expenses — owes $21,000 in tax on the full $100,000 of gross income. The business that looked profitable is, after taxes, in the red. Some cannabis operators have reported effective federal tax rates as high as 80%.

The One Deduction That Still Works: Cost of Goods Sold

Section 280E disallows deductions. It does not, however, disallow the reduction of gross income by cost of goods sold (COGS). Courts have consistently affirmed this distinction, and it is the foundation of every legitimate 280E tax strategy.

COGS, in a cannabis context, includes the direct costs of producing or acquiring the product sold: cultivation labor, growing supplies, processing costs, and the direct acquisition cost of inventory. These amounts reduce gross income before the 280E restriction applies — they are not deductions in the technical sense, but inventory cost reductions.

The implication is significant and precise: cannabis businesses that operate at multiple points in the supply chain — cultivating, processing, and retailing — should work with their tax advisors to correctly allocate costs between production activities eligible for COGS treatment and retail or dispensary activities that are not.

Mischaracterizing expenses as COGS when they are more properly classified as operating expenses is a compliance risk. Failing to capture every legitimate COGS item is leaving money on the table. Both errors are common. Neither is acceptable.

Entity Structure and the Separate-Activity Strategy

Because 280E applies to businesses that traffic in controlled substances, some cannabis operators have structured their operations to isolate activities that do not directly involve the plant — administrative functions, real estate management, and brand licensing — into separate legal entities.

If those entities are genuinely separate (legally, operationally, and spatially), they may be able to claim business expense deductions that the plant-touching entity cannot. The IRS and U.S. Tax Court have scrutinized these arrangements carefully. The separation must be real — not cosmetic. Entities that share employees, management, or resources without appropriate allocation will fail this test.

For cannabis business owners, the relevant question to ask your tax advisor is not “can we structure around 280E?” It is: “Does our current structure reflect the actual operational and legal separation required for the IRS to respect it — and is that structure still optimal given where federal policy is heading?”

Where Things Stand: The Trump Administration and Schedule III

On December 18, 2025, President Trump signed Executive Order 14370, directing Attorney General Pam Bondi to complete the DEA rulemaking process to move marijuana from Schedule I to Schedule III of the Controlled Substances Act “in the most expeditious manner in accordance with Federal law.”

This is the most significant federal action on marijuana scheduling since the DEA’s notice of proposed rulemaking in May 2024, which itself built on a 2023 HHS scientific review concluding that marijuana has a currently accepted medical use.

As of February 2026, the rescheduling is not yet final. The administrative hearing process remains pending before the DEA, with an interlocutory appeal still unresolved. Legal analysts at Ropes & Gray and other firms have noted that litigation risk and administrative procedural requirements could delay a final rule, though the prevailing expectation among industry observers is that rescheduling to Schedule III will be finalized sometime in 2026.

Two things are factually clear. First, rescheduling to Schedule III would remove marijuana from the scope of Section 280E. Cannabis businesses would then be taxed on net income like other businesses, with access to standard deductions for rent, labor, marketing, and other ordinary and necessary business expenses. Industry estimates place the aggregate annual tax savings at approximately $2.3 billion. Cannabis retailers in higher-volume states — such as Maryland — would save an average of $805,000 per store annually, according to an analysis by Cannabis Business Times.

Second, rescheduling would not legalize recreational marijuana at the federal level. Marijuana in Schedule III would still be a controlled substance. State-regulated dispensaries would not become federally licensed operations overnight.

What Cannabis Business Owners Should Be Doing Right Now

The period between a proposed policy change and its effective date is not a waiting period. It is a planning period.

Review your entity structure. Strategies adopted to minimize 280E exposure — including certain C Corporation elections and separate-entity arrangements — may not be the most tax-efficient structure once standard business deductions become available. The analysis that justified your current structure may produce a different answer in a post-280E world.

Audit your COGS methodology. Regardless of rescheduling, maximizing legitimate COGS capture remains the most defensible and impactful tax reduction available under current law. If your COGS methodology has not been reviewed by a CPA with cannabis industry experience within the past 12 months, it should be.

Monitor IRS guidance. Legal advisors have specifically flagged the importance of monitoring interim IRS guidance on the Section 280E transition — including questions about how deductions will be handled in the tax year in which the rescheduling takes effect, and whether prior-year amended returns may be relevant.

Plan for timing uncertainty. Rescheduling could take effect mid-year. It could be delayed by litigation. Tax planning that assumes a specific effective date may need to be revised. Build flexibility into your modeling.

A Future Beyond Section280E?

Section 280E has shaped — and distorted — cannabis business finance for more than four decades. The Trump administration’s December 2025 executive order is a meaningful acceleration of the rescheduling process, and the probability of a 2026 effective date is meaningfully higher than it was a year ago.

But “probable” and “finalized” are not the same thing, and the tax planning decisions cannabis businesses make between now and the effective date of rescheduling will have real consequences.

The operators who come out ahead in a post-280E environment will be the ones who used this window to get their structures right — not the ones who waited for the rule to be published before calling their accountants.

The Wiss tax advisory team works with cannabis businesses navigating the specific compliance demands of operating in a federally complex industry. If you have questions about your current tax structure, COGS methodology, or planning ahead for rescheduling, reach out to discuss what the transition means for your business.