What Is Section 280E? A Plain-English Guide for Cannabis Operators

What does Section 280E actually say?

Section 280E is one sentence long. Paraphrased, it says that no deduction or credit is allowed for any amount paid or incurred in carrying on a trade or business if that business consists of trafficking in controlled substances listed on Schedule I or II of the Controlled Substances Act, where that trafficking is prohibited by federal law or the law of any state where the business operates.

Congress added it in 1982, after a tax case in which a drug dealer successfully deducted business expenses. It was aimed at illegal drug operations. Nobody drafting it was thinking about licensed, inspected, tax-paying dispensaries, but the text doesn't care about state licenses. Courts have consistently treated the sale of state-legal cannabis as “trafficking” for 280E purposes.

Three words in that sentence do most of the work:

• “Deduction or credit.” The ban covers deductions and tax credits. It does not touch the calculation of gross income, which is where cost of goods sold lives.
• “Trade or business.” The disallowance applies to the business that traffics. Whether a separate activity is its own trade or business has been litigated, with mixed results for taxpayers.
• “Schedule I or II.” Schedule III and below are outside 280E entirely. That's why the 2026 rescheduling of medical cannabis matters so much.

Why does 280E produce such high effective tax rates?

A normal business pays tax on net profit: revenue, minus cost of goods sold, minus operating expenses. Under 280E, a cannabis business generally pays tax on something much closer to gross profit, because the operating expenses are disallowed. The tax rate doesn't change. The base it's applied to does.

Here's an illustrative example of a dispensary organized as a C corporation, using the 21% federal corporate rate and ignoring state tax:

Same store, same customers, same $200,000 of real profit. Under 280E, the federal bill is larger than the profit itself. That isn't a hypothetical edge case; it's the basic arithmetic of the rule, and it's why so many operators feel like they're running hard just to stay even.

What does 280E block, and what doesn't it?

Generally disallowed for a business subject to 280E:

• Rent and occupancy costs for retail and office space
• Payroll for budtenders, managers, admin and sales staff
• Advertising, marketing and promotions
• Professional fees, software, insurance and bank fees
• Depreciation on assets not used in production
• Tax credits that would otherwise reduce federal tax

Not blocked by 280E:

• Cost of goods sold. COGS is subtracted to arrive at gross income; it isn't a deduction. The Tax Court has repeatedly confirmed that cannabis businesses may reduce gross receipts by properly computed COGS.
• Costs of a genuinely separate trade or business that doesn't traffic in cannabis, if the facts support it (more on that below).
• Medical activity on or after April 28, 2026, which is now Schedule III.

The catch is that “properly computed” COGS is governed by the inventory rules in IRC 471, and what you can include depends heavily on whether you produce cannabis or simply buy and resell it. We cover that in detail in Cannabis COGS Under IRC 471.

Also worth knowing: 280E is a federal rule. Many states with legal cannabis have decoupled from it for state income tax purposes, but not all have, and the details vary. Check your state's current rules rather than assuming.

What have the courts said about getting around 280E?

Operators and their advisors have tested 280E for years. A few cases shape how practitioners approach it today:

• Harborside (Patients Mutual Assistance Collective Corp. v. Commissioner, Tax Court 2018, affirmed by the Ninth Circuit in 2021). The court held that a cannabis reseller could not use Section 263A to capitalize additional costs into inventory and sidestep 280E, and that resellers and producers include different costs under the 471 regulations. On appeal, the Ninth Circuit also rejected the argument that 280E unconstitutionally taxes more than income.
• CHAMP (Californians Helping to Alleviate Medical Problems v. Commissioner, Tax Court 2007). The court found a caregiving operation was a separate trade or business from its cannabis sales, so its expenses for that activity were deductible. This is the case people cite when they talk about separate businesses.
• Olive (Olive v. Commissioner, Tax Court 2012, affirmed by the Ninth Circuit in 2015). The court found that free activities offered alongside cannabis sales were part of a single trafficking business, not a separate one. It shows how hard the CHAMP argument is to win when the other activity doesn't generate its own real revenue.
• Alterman (Alterman v. Commissioner, Tax Court 2018). Another dispensary case in which the court applied 280E and limited the reseller's inventory costs to those allowed under the 471 rules.

The through-line: courts have been willing to enforce 280E as written, and they've rewarded documentation and punished guesswork. The defensible path is accurate inventory costing, not creative relabeling.

How did Schedule III change 280E in 2026?

An order signed April 22, 2026, effective April 28, 2026, moved state-licensed medical cannabis and FDA-approved cannabis products to Schedule III. Because 280E only reaches Schedule I and II, it generally no longer applies to state-licensed medical activity from that date forward.

What didn't change:

• Adult-use cannabis is still Schedule I and still fully subject to 280E as of mid-October 2026.
• Full rescheduling is still pending. A broader DEA hearing on moving all marijuana to Schedule III began June 29, 2026, was paused September 29, 2026, and had not resumed as of mid-October.
• Prior years are not automatically reopened. The IRS has signaled that rescheduling doesn't reopen closed prior-year positions. 280E guidance is on the IRS priority guidance plan, but don't plan around amending old returns.

For a medical operator with a calendar tax year, 2026 is effectively two periods: before April 28, when 280E applied, and after, when it generally doesn't. Dual-license operators have a harder job: separating medical and adult-use activity and allocating shared costs between them. Our Schedule III and 280E guide walks through the timeline and the dual-license split.

What should cannabis operators do about 280E right now?

1. Confirm which world you're in.Medical-only, adult-use-only or both, by entity and location. Your 280E exposure follows that answer.
2. Get COGS right before anything else.For adult-use activity, inventory costing is still the main lever. Make sure every cost that belongs in inventory under 471 is captured, and nothing that doesn't belong is stuffed in. Our COGS and inventory costing work starts here.
3. Build books that show the split.If you hold both licenses, your chart of accounts, classes and POS data need to show medical versus adult-use activity cleanly from April 28, 2026 forward.
4. Document everything.Timesheets for production labor, square-footage support, inventory counts and a short written memo for each allocation method. Cases are won and lost on records.
5. Re-run your 2026 tax projection.A mid-year effective date changes estimated payments, especially for medical and dual-license operators.

If you're unsure how the Schedule III change splits your year, our free Schedule III Split Check is built for exactly that question.

Frequently asked questions

Published October 21, 2026 by Cash Crop CFO. General information only, current as of publication, and not legal or tax advice for your specific situation.