For as long as most California operators have been licensed, one federal rule has shaped their tax bill more than any other: IRC §280E. In April 2026, a federal order changed how that rule reaches part of the industry. It did not change it for everyone, and several important questions are still open.
Here is what changed, what did not, and how to keep your books ready for either outcome.
A quick refresher on §280E
IRC §280E denies any deduction or credit for amounts paid or incurred in carrying on a trade or business that consists of trafficking in Schedule I or Schedule II controlled substances. For a cannabis business under that rule, rent, wages for sales staff, marketing, and most overhead may produce no federal tax benefit at all.
Cost of goods sold works differently. It reduces gross receipts before income is calculated, so it is not a deduction in the sense §280E disallows. That is why inventory costing has been the main federal lever for operators, and the place examiners look most closely.
What changed in April 2026
On April 23, 2026, the Department of Justice announced a final order placing two categories of marijuana in Schedule III, effective immediately:
- FDA-approved drug products containing marijuana
- Marijuana products regulated by a state medical marijuana license
The same day, Treasury and the IRS announced that they plan to issue guidance on the tax consequences. They stated that rescheduling generally removes §280E as a bar to deductions and credits for activities that no longer involve Schedule I or II substances. They also said they expect a transition rule under which the change generally applies for a business’s full taxable year that includes the order’s effective date.
That is an encouraging signal for medical operators, but it describes planned guidance, not the guidance itself. Nothing announced so far provides relief for tax years before the order. Whether a particular license, product, or entity falls within the order’s terms is also a legal question worth reviewing with your attorney.
What did not change
- Adult-use cannabis is still Schedule I. The order does not cover adult-use (recreational) marijuana, so §280E continues to apply to adult-use activity.
- Unlicensed activity is still Schedule I. Marijuana outside a qualifying state medical license or an FDA-approved product remains in Schedule I.
- Broader rescheduling is still pending. The DEA began a new administrative hearing on broader rescheduling on June 29, 2026. As of this writing, no final decision has been issued.
- Inventory rules still matter. Cost of goods sold and the §471 inventory rules remain central, as discussed below.
Operators with both medical and adult-use sales
Some businesses serve both markets. Treasury has said its guidance is expected to apply §280E only to the activities that still involve Schedule I or II trafficking, with expenses apportioned between activities. As of this writing, Treasury and the IRS have not issued detailed allocation rules.
Until they do, the strongest position is usually the best-documented one. Steps that may help:
- Track medical and adult-use sales separately, by license and by product line
- Record how shared space, staff, and equipment are used by each activity
- Keep time records for employees who work across both
- Hold off on locking in an allocation method until guidance is final, and be ready to adjust
Records built now are far easier to support than allocations reconstructed after the fact.
Cost of goods sold still carries weight
For adult-use activity, cost of goods sold remains the primary federal lever. Inventory follows IRC §471 and the inventory regulations. In Patients Mutual Assistance Collective Corp. v. Commissioner, 151 T.C. No. 11 (2018), the Tax Court held that a business subject to §280E calculates cost of goods sold under §471, not the broader §263A capitalization rules. The court also examined whether the business was a producer or a reseller, which affects which costs can be included.
For medical activity that moves out from under §280E, accurate inventory still matters. Gross income still depends on it, and for operators with both kinds of sales, cost records may become the starting point for any allocation.
California has its own rules
California does not follow §280E for licensed cannabis businesses. According to the Franchise Tax Board, licensed cannabis businesses may deduct cost of goods sold and ordinary and necessary business expenses on the California return, while unlicensed businesses may deduct only cost of goods sold. Under the personal income tax law, this treatment currently applies for taxable years beginning in 2020 through 2029 (California Revenue and Taxation Code §17209).
That means many operators already run two computations from the same books: one federal, one state. Federal rescheduling may narrow the gap for medical activity, but it does not remove the need to reconcile both returns each year.
What to watch next
- Treasury and IRS guidance on the transition rule and on allocation for operators with both kinds of sales
- The outcome of the DEA proceeding on broader rescheduling
- Any change to California’s cannabis deduction rules before the current window closes
How TreeStar can help
We build cannabis books with both the federal and California returns in mind, from inventory costing to the records that support how costs are split between medical and adult-use activity. As federal guidance arrives, we revisit your plan with you and adjust where the rules allow.
This article is general information, not advice for your situation. Rules change; confirm current law before acting.
