Why Rescheduling Matters for IRC §280E

IRC §280E currently disallows ordinary and necessary business deductions for any business “trafficking” in a substance listed under Schedule I or II of the Controlled Substances Act. Because cannabis has long been classified as a Schedule I substance, licensed cannabis operators have been subject to uniquely punitive federal tax treatment—often paying tax on gross income rather than net profit.

Once the Department of Justice finalizes its proposed rule—currently expected in the first half of 2026—cannabis would be reclassified as a Schedule III substance. At that point, cannabis would no longer fall within the scope of IRC §280E. As a result, cannabis businesses would be permitted to deduct ordinary and necessary business expenses, such as rent, payroll, marketing, insurance, and professional fees, on a going-forward basis. This represents one of the most significant federal tax changes in the history of the cannabis industry.

Beyond §280E relief, rescheduling also removes the statutory presumption that cannabis has no accepted medical use and substantially reduces regulatory barriers to federal research. Researchers would gain improved access to research-grade cannabis, expanded eligibility for federal grants, and greater ability to conduct large-scale studies on medical efficacy, safety, and public health impacts.

What Cannabis Operators Should Do Now

• Timing and Uncertainty: Rescheduling is not effective until the final rule is adopted and may face legal or procedural challenges. Operators should maintain strong compliance, disclosure, and documentation practices during the transition period.
• Stronger Legal Position on §280E: Rescheduling fundamentally changes the statutory analysis. Once cannabis is no longer a Schedule I or II substance, the legal basis for applying IRC §280E going forward is eliminated.
• Estimate Future Tax Savings: Model the impact of restoring full deductions and quantify the expected reduction in federal tax liability once §280E no longer applies.
• Update Cash Flow Projections: Revise financial forecasts to reflect increased after-tax cash flow and improved margins.
• Scenario Planning: Compare multiple timelines, such as rescheduling effective mid-2026 versus delayed implementation, and assess the impact on financial performance and liquidity.
• Reinvestment Strategy: Determine how freed-up cash will be deployed, including expansion, debt reduction, technology investments, or reserve building.
• IRS Audit and Settlement Opportunities: Once rescheduling occurs, §280E becomes a non-continuing issue. This may create opportunities to resolve open IRS audits, appeals, or disputes more favorably. Operators should review unresolved §280E matters, engage tax counsel early, quantify exposure versus likely settlement ranges, maintain reasonable-basis documentation for prior years, and monitor timing, as settlement dynamics may improve after the final rule is adopted.

This is a pivotal development for the cannabis industry. Once rescheduling is finalized, cannabis businesses will no longer be subject to IRC §280E’s harsh limitations and will finally be taxed like other legitimate businesses—on net income, not gross receipts. For additional information, contact one of our cannabis industry team members at [email protected] or 602.776.6300.