Executive Order Accelerates Reclassification for Medical Marijuana, Keeps Reclassification Timeline Started Under Biden Administration

By: Matthew E. Foreman and Tonya L. Hurd

On April 23, 2026, the Department of Justice (DOJ) and the Drug Enforcement Administration (DEA) issued an executive order (the Order)¹ to move (i) products approved by the Food and Drug Administration (FDA) containing marijuana and (ii) marijuana products regulated by a state medical marijuana license, from Schedule I of the Controlled Substances Act (CSA) to Schedule III.² At the time this article was written, only three prescription drugs containing cannabis or cannabis-derived compounds have been approved by the FDA as safe and effective for use.³ The Order states that “any form of marijuana other than in an FDA-approved drug product or marijuana subject to a state medical marijuana license remains a schedule I controlled substance.”⁴ Therefore, only medical marijuana will be reclassified to Schedule III, while recreational marijuana remains a Schedule I controlled substance. The process started by the Biden Administration in May 2024 to reschedule recreational marijuana was not modified by the Order, though an administrative hearing is scheduled for June 29, 2026, with submissions due by May 24, 2026.

State-legal medical marijuana businesses operate under a federal⁵ tax regime⁶ that many cannabis advocates view as punitive. While cannabis businesses are generally subject to federal income tax like any other business, Internal Revenue Code (the Code) section 280E has prevented businesses “trafficking in controlled substances” from deducting most ordinary and necessary business expenses, often turning what would otherwise be an income tax into something that is closer to a gross receipts tax due to the loss of deductions under section 162. The reclassification of medical marijuana from Schedule I to Schedule III will allow many cannabis businesses to begin deducting some of their ordinary and necessary business expenses, which will lower their effective tax rates significantly.

The Order rescheduling medical marijuana is meaningful for cannabis businesses, but it is not a decriminalization of marijuana, nor does it remove cannabis-related businesses from the reach of section 280E. This article explains the effect that section 280E has on cannabis-related businesses, describes tax planning for cannabis businesses under section 280E, explores the effects of reclassifying marijuana from Schedule I to Schedule III, and identifies possible challenges that may arise from the rescheduling.

I. Section 280E of the Code

Section 280E of the Code was enacted in 1982, after the Tax Court allowed a cocaine dealer to deduct the “ordinary and necessary expenses of his illicit trade.”⁷ Section 280E provides that no deduction or credit is allowed for amounts paid or incurred in carrying on a trade or business if that trade or business consists of trafficking in controlled substances,⁸ and trafficking includes activities that are prohibited by Federal law or the law of any State in which the business is conducted.⁹

Because cannabis is a Schedule I controlled substance, Section 280E has been difficult for cannabis businesses, as it denies deductions for many of the expenses that drive operating results, such as payroll, rent, marketing, insurance, repairs, and professional fees. The loss of deductions results in effective federal tax rates that are significantly higher than those of similarly situated non-cannabis businesses.

Under the Order, section 280E will no longer apply to businesses that sell state-legal medical marijuana. The Order states that “holders of state medical marijuana licenses will no longer be subject to the deduction disallowance imposed by Section 280E of the Internal Revenue Code.”¹⁰ The Order “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.”¹¹

The Treasury and the IRS have already acknowledged the significance of the Order, stating that “rescheduling generally 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.”¹²

II. Current Tax Planning Around Section 280E

Because section 280E disallows deductions, planning has generally focused on three areas: (i) inventory and cost capitalization planning; (ii) section 471(c) small-business inventory methods; and (iii) “two-business” strategies and expense segregation.

a. Inventory and cost capitalization planning

For cannabis producers and resellers, the starting point is that cost of goods sold (COGS) reduces gross receipts in computing gross income, and section 280E does not alter that basic mechanic. The Code and Treasury Regulations (the Regulations) determine what properly goes into COGS: resellers look to Regulation section 1.471-3(b) (invoice price plus transportation/necessary acquisition charges), while producers must capitalize direct materials and labor and specified indirect production costs under Regulation sections 1.471-3(c) and 1.471-11. Courts have repeatedly held that, even when section 280E disallows ordinary and necessary deductions, taxpayers selling marijuana still compute COGS under section 471 and its Regulations, not under bespoke theories.¹³

By contrast, attempts to inflate COGS by capitalizing expenses that would otherwise be disallowed under section 280E generally fail. The Code’s capitalization rules under section 263A¹⁴ broadly capitalize indirect costs, but section 263A(i) exempts qualifying small business taxpayers and, in any event, section 263A’s flush language limits capitalization to costs that are otherwise taken into account in computing taxable income, undercutting efforts to recharacterize section 162-type selling, general, and administrative expenses into inventory for section 280E taxpayers.¹⁵ The IRS has likewise advised that examiners may require inventory methods that clearly reflect income and compute COGS under section 471 rather than permitting deduction-era shortcuts.¹⁶

b. Misconceptions about Section 471(c) small-business inventory methods

Section 471(c) gives “small business taxpayers”¹⁷ flexibility in how they account for inventory, permitting them either to treat inventory as non‑incidental materials and supplies or to conform to the method used in their financial statements (or, if none, their books and records).¹⁸

Changing a business’s accounting method into a method that utilizes section 471(c) is a change in accounting method requiring consent under section 446(e) and a section 481(a) adjustment, generally via Revenue Procedure 2015‑13. Aggressive uses of section 471(c) to “nullify” section 280E risk accuracy‑related penalties absent substantial authority and reasonable reliance.¹⁹ Put bluntly, section 471(c) is a presentation/timing safe harbor, not a backdoor to stuff retail‑facility handling, showroom labor, or other ordinary and necessary business expenses into COGS. The theory that section 471(c) lets retailers “capitalize like producers” or sidestep section 280E collides with the text and structure of sections 471, 263A, and 280E, not to mention the Tax Court’s insistence that substance, not labels, controls capitalization.²⁰

c. “Two-business” strategies and cost segregation

Taxpayers sometimes pursue a “two-business” approach that separates a non-cannabis trade or business from the cannabis business because section 280E disallows deductions only for the trade or business that “consists of trafficking” in substances that are listed in Schedules I or II. The Tax Court in Californians Helping to Alleviate Med. Problems allowed deductions allocable to a genuinely separate caregiving business while denying those tied to marijuana sales.²¹ However, where the record shows a single integrated marijuana business (e.g., ancillary sales or services are economically inseparable, or revenue is overwhelmingly from cannabis), courts have treated it as one section 280E-affected trade or business.²²

Cost segregation and rigorous allocations can still matter because the capitalization rules for cannabis producers permit capitalization of indirect production costs, while nonproduction selling and administrative costs remain subject to section 280E’s disallowance.²³ The line-drawing must be grounded in contemporaneous records and operational reality; courts have been skeptical when “separate” activities lack independent revenue, personnel, or business purpose beyond avoiding section 280E.²⁴ In short, well-supported allocations between production and retail, as well as distinct non-cannabis lines, can move the needle, but relabeling business expenses or overhead as COGS, or creating paper separations rarely survives section 471 and section 280E scrutiny.

III. What is the Effect of Rescheduling?

The Order expressly acknowledges the effect that reclassifying marijuana as a Schedule III drug will have on income tax law. The disallowance of deductions is tied specifically to Schedule I and Schedule II drugs; businesses producing, manufacturing, transporting, or selling Schedule III drugs, such as medical marijuana and FDA-approved marijuana products, will be able to deduct ordinary and necessary business expenses under section 162.²⁵

That means the analysis should revert to the usual business deductions regime, starting with section 162(a) for operating expenses, as well as the inventory/capitalization rules of sections 471 and 263A for costs that must be capitalized and recovered through COGS.

For companies that cultivate, sell, and process state-legal medical marijuana products, the practical implications are potentially profound:

• The ability to deduct payroll, rent, utilities, marketing, professional fees, insurance, and other overhead could materially reduce taxable income.
• Effective tax rates could drop sharply.
• Cash flow may improve (especially for businesses that have been profitable on a pre-tax basis but cash-tax constrained).
• Financial statement presentation and valuation may change, especially for businesses whose reported earnings have been distorted by 280E-driven cash taxes.

Even if cannabis remains regulated and constrained under federal law, which it is likely to remain, section 280E will have less of an effect, and possibly no effect whatsoever, on cannabis businesses. Businesses should not assume that rescheduling eliminates all federal legal risk, but from a federal income tax perspective, rescheduling cannabis from Schedule I to Schedule III is the key to ending section 280E’s disallowance rule.

IV. Effective Date And Transitional Issues

The Order became effective upon publication in the Federal Register on April 28, 2026.²⁶ That timing matters because section 280E is applied on a taxable-year basis to “amount[s] paid or incurred during the taxable year,” and because the characterization of costs as deductible expenses,²⁷ capital expenditures,²⁸ capitalized inventory costs,²⁹ or other timing items depends on the taxpayer’s methods of accounting under section 446 and related regulations.

In practice, the transition can raise issues that are not glamorous enough for a press release but are absolutely glamorous enough for an IRS exam:

• Cutover mechanics. What is the correct treatment of expenses incurred before vs. after the effective date, especially where costs are prepaid, accrued, or capitalized? Specifically, if a cannabis business were to avail itself of section 471(c), it must continue such treatment or request permission from the Secretary of the Treasury to change its accounting method.
• Method-of-accounting changes. If the business’s historical approach to inventory and capitalization was shaped by section 280E constraints, any changes must be evaluated under section 446 and may require consent and a section 481(a) adjustment.
• Documentation. Businesses should assume that the “post-280E” world still requires rigorous substantiation under IRC section 6001 and the inventory recordkeeping rules in the section 471 regulations.

Finally, the Order also includes a caution that nothing in the rule is a determination of federal tax liability and advises state licensees to consult tax counsel regarding the applicability of section 280E to their specific circumstances.³⁰