Medical Marijuana Rescheduling and Section 280E

On April 23, the DOJ issued a final order moving certain medical marijuana products from Schedule I to Schedule III of the Controlled Substances Act (CSA), opening the door to allowing marijuana companies to claim deductions for eligible expenses that previously were prohibited under Section 280E. The order applies to marijuana contained in Food and Drug Administration (FDA)-approved products or subject to state medical marijuana license, as well as certain marijuana extracts and certain naturally derived delta-9 tetrahydrocannabinols. The order, which is effective April 22, also encourages Treasury to apply Section 280E relief retroactively.

The final order leaves unlicensed marijuana crops, bulk marijuana, and marijuana or marijuana extract not yet incorporated into an FDA-approved drug product in Schedule I.

Background

Section 280E provides:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Although various forms and uses of marijuana are now legal under some state laws, prior to April 22, all marijuana was listed as a Schedule I under the CSA, and therefore subject to the Section 280E deduction disallowance for federal income tax purposes.

The DOJ order rescheduling certain medical marijuana from Schedule I to Schedule III recognizes the significant impact this change will have on federal tax law. Specifically, the order states:

The Administrator further notes that, as a consequence of this rule, holders of state medical marijuana licenses will no longer be subject to the deduction disallowance imposed by Section 280E of the Internal Revenue Code, which applies only to businesses engaged in “trafficking in controlled substances ... in a schedule I or II,” 26 U.S.C. § 280E. The Administrator encourages the Secretary of the Treasury to consider providing retrospective relief from Section 280E liability for taxable years in which a state licensee operated under a state medical marijuana license. Nothing in this rule constitutes a determination regarding federal tax liability, and state licensees should consult with tax counsel regarding the applicability of Section 280E to their specific circumstances.

On the same day that the DOJ’s order was issued, Treasury issued a press release announcing that Treasury and the IRS plan to issue guidance addressing the federal tax consequences of the DOJ’s final order. The Treasury press release restates that rescheduling removes Section 280E as a bar to claiming deductions and credits for businesses that, as a result of the final order, no longer traffic in Schedule I or II controlled substances under the CSA. The press release also states that Treasury and the IRS expect the guidance to address how Section 280E applies to businesses with multiple activities, including expense apportionment where some activities continue to involve Schedule I or II controlled substances.

Additionally, the press release provides that Treasury and the IRS expect forthcoming guidance to include a transition rule providing that, for Section 280E purposes, the order will apply to the first full taxable year that includes the effective date of the DOJ’s final order.

Crowe observation

The ability to claim deductions for the full tax year that includes April 22, 2026, the effective date of the order, is welcome. However, depending on a cannabis business’s tax year and particular facts and circumstances, figuring deductible expenses and those that remain subject to Section 280E could be complicated and burdensome unless guidance provides safe harbors and other simplified methods.

What cannabis businesses can do now

To prepare to claim expenses that no longer are subject to Section 280E, cannabis businesses should consider taking the following steps:

• Evaluate product and revenue streams. Businesses should identify which products and activities fall within the DOJ’s final order and which remain subject to Schedule I treatment.
• Review expense allocation methods to model tax impact for the year of rescheduling. Because Treasury and the IRS expect guidance to provide transition relief for eligible activities for the full tax year, businesses should model the effect on estimated taxes, cash tax forecasts, and financial statement tax provisions. Businesses that now have both Schedule III and Schedule I activities and products should review documentation to ensure that it is sufficient to support allocation of expenses between deductible and nondeductible activities and products.
• Assess accounting method implications. Businesses should evaluate inventory, cost capitalization, depreciation, and other tax accounting methods to optimize tax planning when transitioning away from prior-year application of Section 280E.
• Monitor Treasury and IRS guidance. Forthcoming guidance is expected to address principal federal tax issues stemming from the DOJ’s final order, including expense apportionment and transition rules. Taxpayers should be prepared to provide public comments.
• Consider amended return and refund opportunities. Once guidance is issued, taxpayers should evaluate whether there are opportunities to amend returns, estimated tax payments, or financial statement positions.
• Evaluate IRS exam and litigation strategy. Cannabis businesses currently under IRS examination or involved in administrative appeals or litigation involving Section 280E should discuss with their tax advisers and legal counsel how the DOJ’s final order and forthcoming Treasury and IRS guidance could affect exam responses, settlement discussions, refund claims, protective filings, or litigation strategy.

Looking ahead

The rescheduling of certain marijuana items from Schedule I to Schedule III has created significant opportunities for cannabis companies, including deductibility of certain cannabis-related expenses that previously were not deductible under Section 280E. The DOJ press release indicates further hearings in June on the status of marijuana, providing the potential for expanding the categories of marijuana that are rescheduled. While rescheduling and the related relief from the Section 280E limitation is welcome, it is likely that the industry will experience additional changes. Companies should continue to monitor developments and discuss with their tax and legal advisers any questions about which Schedule an item falls under or how these changes affect them.

Qualified organizations only. Independence and regulatory restrictions may apply. Some firm services may not be available to all clients. Given the continued evolution and inconsistency of various state and federal cannabis-related laws, any company should seek competent legal advice relating to its involvement in the cannabis industry, including when considering a potential public offering as a cannabis-related company.