If you own a licensed cannabis business anywhere in the United States, you have spent years paying tax on gross profit instead of net income. Section 280E of the Internal Revenue Code has denied you the ordinary deductions every other business takes — rent, payroll, marketing, professional fees — because your product sat on Schedule I of the Controlled Substances Act. That changed in April 2026, but not for everyone, and not in the way most operators assume.

On April 22, 2026, the Department of Justice issued a final order moving state-licensed medical cannabis and FDA-approved marijuana products to Schedule III, effective April 28, 2026. Treasury and the IRS acknowledged the shift carries significant tax consequences. Adult-use cannabis, however, remains on Schedule I and remains fully subject to 280E. For the many operators holding both license types — a structure common in California, Colorado, Michigan, Massachusetts, Nevada, and every other dual-market state — that split creates a genuinely difficult allocation problem and a real audit risk.

The Law Office of Pietro Canestrelli, A.P.C. represents cannabis businesses in federal and state tax matters from offices in Temecula and San Diego, serving clients throughout California and across the country. This article explains what the rescheduling changed, who qualifies for deductions now, how to handle a dual-license operation, and what to do about prior tax years. For a direct answer on your specific license structure, schedule a consultation with our tax attorneys.

What Section 280E Says and Why It Hurt So Much

Section 280E denies any deduction or credit for a trade or business that consists of trafficking in controlled substances listed on Schedule I or Schedule II. The statute is short and blunt. It does not carve out state-legal operations, and courts consistently upheld it against cannabis businesses in every state for more than a decade.

One narrow relief valve always existed. Cost of goods sold is not a deduction — it is a reduction in gross receipts required to arrive at gross income under Section 61 and the inventory rules of Section 471. So cultivators, who can capitalize a large share of production costs into inventory, historically fared better than retailers, whose costs are overwhelmingly the exact selling and administrative expenses 280E disallows. That asymmetry is why dispensaries from San Diego to Denver to Detroit frequently paid effective federal rates north of 60 percent on real economic profit.

What the April 2026 Rescheduling Actually Did

Because 280E applies only to Schedule I and Schedule II substances, moving covered cannabis to Schedule III removes it from the statute’s reach. Businesses within the covered category can deduct ordinary and necessary business expenses under Section 162 like any other taxpayer.

Three limits matter, and they are where operators get into trouble:

• Coverage is narrow. The order reaches state-licensed medical cannabis and FDA-approved marijuana products. Adult-use recreational cannabis stayed on Schedule I.
• Timing is forward-looking. For calendar-year taxpayers, relief generally applies from January 1, 2026 forward. IRS signals have discouraged retroactive claims for closed years.
• Allocation guidance is still pending. Treasury has not issued detailed rules on how dual-license operators split expenses between covered and non-covered activity.

Who Qualifies, and Who Does Not

License designation now carries real federal tax weight, and the terminology varies by state. California distinguishes medicinal (M) from adult-use (A) designations through its Department of Cannabis Control. Other states separate medical and recreational licensure through different regulatory bodies and naming conventions. The federal question is the same everywhere: is this activity state-licensed medical cannabis, or is it adult-use?

Likely covered

• State-licensed medical retailers, distributors, cultivators, and manufacturers operating under valid license
• Businesses handling FDA-approved cannabis-derived pharmaceutical products

Still subject to 280E

• Adult-use operations of any license type
• Unlicensed operators — state licensure is doing real work here
• The adult-use portion of a dual-license business

Delta-8 and hemp-derived cannabinoid businesses sit in their own category governed by the 2018 Farm Bill’s THC threshold, not by this order. If your product line straddles that line, the classification question deserves attention before you file.

The Dual-License Allocation Problem

Most established operators in mature markets hold both medical and adult-use privileges, often selling from the same counter, staffed by the same employees, in the same leased building. Beginning with the 2026 tax year, those shared costs must be split between deductible medical activity and non-deductible adult-use activity.

No safe harbor exists yet. In our experience with allocation disputes across industries, examiners accept methods that are consistently applied, documented contemporaneously, and tied to an economically defensible driver. Methods worth evaluating with counsel include:

1. Gross receipts ratio. Simple and easy to support from point-of-sale data, but crude where medical transactions carry different margins.
2. Transaction count. Better for allocating labor and occupancy where medical sales are smaller-ticket.
3. Square footage and direct tracing. Strongest where you maintain physically separate inventory, registers, or staff.
4. Hybrid. Direct-trace what you can, then allocate genuine shared overhead by a receipts or transaction driver.

Whatever method you choose, choose it before year-end and paper it. The single most common failure we see in audit defense is a reasonable allocation constructed after the notice arrives with no contemporaneous support. That looks like reverse-engineering to an examiner and invites penalties on top of the adjustment. Our business tax audit representation practice handles exactly these methodology fights.

What About Prior Years? The Amended Return Question

Many operators want to file protective refund claims for 2022 through 2025, arguing the rescheduling should apply retroactively. Understand the posture before you spend money on it.

The general refund window under Section 6511 is three years from the filing date or two years from payment, whichever is later. That window remains open for several recent years. But the IRS has signaled it does not view rescheduling as reopening closed positions, and it has previously warned publicly about cannabis operators filing amended returns claiming 280E does not apply. Several large multistate operators pursued that theory before rescheduling and drew significant scrutiny.

A protective claim can preserve the statute while litigation develops elsewhere. That is a strategic decision about audit exposure and cost, not a routine filing. If you are weighing it, talk to a tax attorney rather than filing amended returns and hoping. Our IRS representation team can evaluate the exposure alongside the potential recovery.

Your State Probably Has Different Rules

Federal treatment is only half the calculation. States handle cannabis taxation independently, and several decoupled from 280E for state income tax purposes years before rescheduling. California is among them — licensed commercial cannabis businesses have been permitted state deductions that federal law denied. Other states never adopted 280E conformity at all, while some track federal treatment exactly.

Practically, this means your federal and state returns have been diverging, and the direction of that divergence just shifted. Book-to-tax reconciliation for 2026 will not resemble 2025 in any dual-market state. Whoever prepares your returns needs to model each jurisdiction rather than starting from the federal number and adjusting casually.

Layer on state excise taxes — California’s cannabis excise administered by the CDTFA is one example among many — and you have several tax systems with several sets of rules. Excise and sales tax audits of cannabis retailers have been an enforcement priority in every legal market, and an excise audit frequently produces the records that make an income tax examination easy. Our CDTFA representation practice sees these cases move together in California, and the same pattern repeats nationally.

Five Mistakes to Avoid This Year

1. Assuming rescheduling ended 280E entirely. Adult-use revenue is still exposed. Treating the whole operation as deductible is the fastest route to an adjustment with penalties.
2. Abandoning cost-of-goods discipline. Section 471 inventory methodology still matters for the non-covered side of your business. Do not dismantle the capitalization workpapers protecting you.
3. Choosing an allocation method at filing time. Decide now, document the reasoning, and apply it consistently across quarters.
4. Ignoring entity structure. Some operators are evaluating separate legal entities for medical and adult-use activity. That can clarify allocation but carries licensing, transfer pricing, and business formation consequences that need modeling first.
5. Filing aggressive amended returns without counsel. Refund claims in this space attract attention. Know your exposure before you invite the look.

Frequently Asked Questions

Does Schedule III rescheduling eliminate Section 280E for my dispensary?

Only for the medical portion of your business. State-licensed medical cannabis moved to Schedule III effective April 28, 2026, so 280E no longer applies to that activity. Adult-use cannabis remains Schedule I and fully subject to 280E, which means dual-license retailers must allocate shared expenses between the two.

Can I amend prior year returns to claim deductions 280E denied?

You can file, but not casually. The IRS has discouraged retroactive application and previously scrutinized cannabis operators filing amended returns on 280E theories. A protective refund claim may preserve the statute of limitations, generally three years from filing under Section 6511. Have a tax attorney evaluate the audit exposure first.

What allocation method should a dual-license operator use?

No safe harbor has been issued. Direct tracing of separately tracked inventory, staff, and space is the strongest position, with a gross receipts or transaction-count ratio applied to true shared overhead. Document the method before year-end and apply it consistently.

Do states allow cannabis business deductions?

It varies. Several states, including California, decoupled from 280E for state income tax purposes and permitted deductions federal law disallowed. Others follow federal treatment. Your federal and state calculations may differ substantially and must be prepared separately rather than derived from one another.

Will a state excise or sales tax audit affect my income tax position?

Frequently. Excise examinations produce detailed transaction-level records, and discrepancies between reported excise figures and reported income are a common referral trigger. Coordinating the response across agencies from the outset protects you in ways that handling them separately does not.

Does rescheduling help hemp or delta-8 businesses?

No. Hemp and hemp-derived cannabinoids under the federal THC threshold were never controlled substances subject to 280E, so their tax position is unchanged. If your product line sits near that threshold, the classification analysis deserves attention before filing.

Your Next Step

The rescheduling is real relief, but it is partial relief. The operators who capture it cleanly will be the ones who build defensible allocation records before their first post-rescheduling return is filed. The ones who assume 280E simply disappeared will meet an examiner.

Pietro Canestrelli holds an LL.M. in Taxation and has spent his career representing taxpayers against the IRS and state tax authorities. Our firm serves cannabis operators throughout Southern California and multistate operators nationwide. Contact The Law Office of Pietro Canestrelli to discuss your license structure, allocation methodology, and prior-year exposure. Our Temecula office and San Diego office both handle cannabis tax matters, and we represent clients in every state.