IRC 280E Explained: The 2026 Cannabis Tax Guide (COGS, 471, Schedule III)

By GreenGrowth CPAs Cannabis Team · Updated October 2026 · Cannabis Tax

IRC 280E denies every federal deduction and credit to a business that traffics in a Schedule I or II controlled substance, and adult-use cannabis is still Schedule I. Your only federal offset is cost of goods sold, so how you calculate and track COGS under Section 471 largely sets your federal tax bill.

The ground shifted in 2026. State-licensed medical marijuana moved to Schedule III on April 28, 2026, so 280E no longer reaches that activity going forward. Adult-use sales stay under 280E.

IRC 280E: At a Glance

• The rule: No deduction or credit for a business trafficking in Schedule I or II controlled substances.
• The exception: COGS is not a deduction, so it still reduces gross receipts.
• Resellers vs. producers: Resellers capitalize product and acquisition costs; producers add labor and production overhead.
• Section 263A: Not available to 280E taxpayers, per Harborside (Tax Court 2018, Ninth Circuit 2021).
• 2026 change: State-licensed medical marijuana is Schedule III as of April 28, 2026; adult-use remains Schedule I.

What Does IRC 280E Say?

Section 280E is one sentence long. It denies any deduction or credit for amounts paid or incurred in a trade or business that consists of trafficking in Schedule I or II controlled substances. The rule applies when federal law or the law of the state prohibits that trafficking.

Federal law still prohibits marijuana, so a state license does not change the federal answer. The IRS says this directly in its cannabis guidance. Rent, payroll, marketing, security, and professional fees all become nondeductible, and credits are lost too.

Why COGS Is the Only Federal Relief

Section 280E blocks deductions and credits. Cost of goods sold is neither. It is a reduction of gross receipts in arriving at gross income, which comes before any deduction. The IRS confirms that 280E does not stop a cannabis business from reducing gross receipts by properly calculated COGS.

That makes inventory costing the main lever you control. A cost that belongs in inventory under the Section 471 regulations reduces taxable income; a cost booked as operating expense is lost. Our guide to cannabis COGS cost tracking and allocation walks through the bookkeeping side in more detail.

Section 471 for Resellers vs. Producers: What Goes Into COGS

The regulations treat resellers, such as dispensaries buying packaged product, differently from producers, such as cultivators and manufacturers. Vertically integrated operators need separate cost pools for each.

A dispensary has a narrow COGS base, so its wins come from capturing all freight-in, applying vendor discounts correctly, and costing shrink consistently. A producer has far more room when it tracks costs by facility and function. See our dispensary accounting services.

Why Section 263A Is Off the Table

Section 263A, the uniform capitalization rules, normally pulls more overhead into inventory. Some dispensaries used it to move store costs into COGS until Harborside ended that approach.

In Patients Mutual Assistance Collective Corp. v. Commissioner, 151 T.C. 176 (2018), the Tax Court held that a dispensary subject to 280E must compute COGS under the Section 471 regulations for resellers. Under the flush language of Section 263A(a)(2), a cost that could not otherwise reduce taxable income cannot be capitalized. Because 280E disallows those costs, 263A cannot revive them. On April 22, 2021, the Ninth Circuit affirmed.

Separate Trade or Business (CHAMP) and Its Limits

Taxpayers have one real win on scope: Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007), or CHAMP. The Tax Court found that CHAMP ran a genuine caregiving business separate from its marijuana activity, so those caregiving expenses stayed deductible.

Later cases show how narrow that door is. In Olive v. Commissioner, the Ninth Circuit held that free services offered alongside marijuana sales were not a separate trade or business. A separate business needs its own revenue, economic substance, and books; branded apparel at the register will not qualify. Licensing intellectual property through a separate entity is one structure some operators review, and we cover its risks in using IP royalties to manage 280E.

What 280E Does to Your Effective Tax Rate: A Hypothetical

The example below is hypothetical and simplified. It assumes a C corporation dispensary paying only the 21% federal corporate rate, with no state tax and no medical sales.

Hypothetical illustration only. The third column assumes $150,000 of freight-in and acquisition charges were moved from operating expense to inventory under Treas. Reg. 1.471-3(b). Actual results depend on your facts.

Under 280E, the tax follows gross profit, not book profit. Each dollar correctly moved into COGS saves 21 cents of federal tax in this example. See our cannabis tax rates by state for the excise and sales tax layer on top.

How to Track Cannabis COGS in Real Time

Real-time COGS tracking means your general ledger knows the cost of every unit you sell when you sell it. You build that by tying your seed-to-sale system, your point of sale, and your accounting system together, then closing inventory every month.

Integrate Seed-to-Sale and POS With the Ledger

Your state tracking system, such as Metrc in many states, records every package and transfer. Your POS records every sale. Map both to inventory items in your accounting system so each sale relieves inventory at cost. A POS that pushes only revenue totals leaves cost data trapped until year end.

Use Standard Costs and Review Variances

Set a standard cost for each SKU or batch, including freight for resellers and labor and overhead for producers. Compare actual costs to standard monthly. Large variances usually point to missed freight, wrong counts, or unrecorded waste.

Close Inventory Monthly

• Count high-value SKUs weekly and the full store or facility at least monthly.
• Reconcile the physical count to seed-to-sale and to the ledger balance.
• Record shrink, samples, and destroyed product with documentation.
• Allocate production overhead to batches using a written, consistent method.

IRC 280E After the 2026 Schedule III Order

Acting Attorney General Todd Blanche signed the final order on April 22, 2026. It appeared in the Federal Register as document 2026-08176 and took effect April 28, 2026. The order places FDA-approved marijuana drug products and marijuana held under a state medical marijuana license in Schedule III. It also creates expedited DEA registration for state medical licensees. Adult-use marijuana remains Schedule I, so 280E still applies to adult-use sales.

Treasury and the IRS announced on April 23, 2026, that they plan to issue guidance. They said rescheduling generally removes 280E as a bar for businesses that no longer traffic in Schedule I or II substances. The forthcoming guidance is expected to include a transition rule that applies relief for the full taxable year that includes the effective date. For a calendar-year medical operator, that points to all of 2026. The announcement does not say whether DEA registration is a condition.

Broader rescheduling is still unsettled. A DEA administrative hearing on rescheduling marijuana generally ran from June 29 to July 15, 2026. On September 29, 2026, the presiding judge paused the proceeding while deciding whether to admit a new GAO report into the record. Separate petitions challenging the April order are pending in the D.C. Circuit. Our Schedule III rescheduling guide for dispensaries tracks these developments.

Dual Licenses: Allocating Medical and Adult-Use Costs

Operators with both medical and adult-use activity now sit on both sides of the line. Treasury expects its guidance to explain how 280E reaches only the Schedule I or II activity, for example by apportioning expenses. Until then, build a defensible method:

• Track medical and adult-use revenue separately in the POS from April 28, 2026, forward.
• Assign direct costs, such as medical-only staff, to the activity that caused them.
• Allocate shared costs, such as rent and security, by revenue, square footage, or labor hours, and document the method.

Expect the IRS to test your allocation. Our article on 280E expense allocation between medical and adult-use costs covers drivers and documentation in more depth.

States That Decouple From 280E

Many states let licensed cannabis businesses deduct, on the state return, expenses that 280E disallows. The table lists only states we confirmed on state government sources. Rules differ by license and tax type.

Note the Michigan twist. After April 28, 2026, a medical provisioning center may get federal relief but no Michigan deduction, while an adult-use store gets the reverse.

Amended Returns and Refund Claims: Proceed With Caution

The IRS said in June 2024 that amended-return claims arguing 280E does not apply are not valid. Treasury's 2026 transition rule points to the taxable year that includes April 28, 2026. It does not reopen earlier years.

A weak refund claim can bring penalties and an exam of other years. Weigh the theory, the limitations period, and your audit exposure first. Our post on whether to file an amended 280E refund claim explains the risk in plain terms.

280E Audit Defense: What to Have Ready

Cannabis exams focus on gross receipts and COGS. Keep these records ready for every open year:

• Monthly inventory counts reconciled to seed-to-sale and the ledger.
• Vendor invoices and freight bills supporting every dollar in COGS.
• Cash logs, bank deposits, and Form 8300 filings that tie to POS revenue.
• Your medical and adult-use allocation workpapers for 2026 forward.

For a fuller checklist, read 280E audit defense: what you would hand an examiner. Our cannabis CPA and tax team can also prepare these files before an exam starts.

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