09.16.2026

The cannabis industry has grown significantly in recent years, with medical and recreational sales continuing to expand as more states legalize use. The industry has matured beyond its early days following legalization and is leaving behind the stigmas and legal barriers that existed prior to 2012.

One such legal barrier is the denial of the ordinary business expense deduction under Internal Revenue Code Section 280E. The rule remains a central concern for adult-use cannabis businesses in 2026. But a limited federal scheduling action has created a fundamentally different tax posture for qualifying state-licensed medical-cannabis activity.

The result is not a universal end to 280E. It is a divided federal landscape that requires careful attention to the substance of the business, the applicable licenses and the source of its revenue.

What is 280E and How Does it Apply to Cannabis Businesses?

This code section disallows tax deductions for ordinary business expenses for businesses involved in the “trafficking” of controlled substances that are classified under Schedule I or II of the Controlled Substances Act (CSA). This includes cannabis, which remains a Schedule I substance at the federal level despite state-level legalization for its medical or recreational use.

The primary impact of Section 280E on cannabis businesses is that it significantly increases their federal income tax burden. Unlike other businesses that can deduct a range of operating expenses, such as rent, salaries and marketing costs from their gross income to determine their taxable income, cannabis businesses are prohibited from taking these deductions. The only deduction allowed under 280E for cannabis businesses is the Cost of Goods Sold (COGS), which includes the direct costs associated with producing or purchasing inventory.

This restriction has led to a situation where cannabis businesses, operating legally under state laws, face effective tax rates that are substantially higher than those of similar businesses in other industries. It's not uncommon for cannabis businesses to face effective tax rates of 70% or higher because they are taxed on their gross income rather than their net income after the deduction of ordinary business expenses.

The impact of 280E creates significant financial strain on cannabis businesses which already have elevated licensing and regulatory costs. The practical outcome of the additional income tax cost is that cannabis businesses have a reduced ability to reinvest in their operations, hire new employees and expand their businesses.

As states began legalizing cannabis, the application of 280E to cannabis businesses became a point of contention with the federal government. The argument for the inapplicability of 280E to cannabis is that it unfairly penalizes businesses that are complying with the strict compliance framework already present in state laws when compared to non-cannabis businesses who can deduct their ordinary business expenses.

Efforts to reform 280E have included legislative proposals such as The Small Business Tax Equity Act, which seeks to exempt cannabis businesses operating in compliance with state laws from the 280E provision. Additionally, some states have taken steps to provide tax relief at the state level by decoupling their tax codes from the federal restrictions imposed by 280E. These efforts, while a step in the right direction, do not address the applicability of 280E to federal income tax returns.

The 2026 Federal Change

In April 2026, the U.S. Department of Justice and Drug Enforcement Administration placed two categories of cannabis in Schedule III: FDA-approved cannabis products and cannabis or cannabis-containing products subject to qualifying state-issued medical-cannabis licenses. The action is consequential because Section 280E reaches only Schedule I and II substances. Qualifying medical-cannabis activity that is now within Schedule III has a strong statutory basis for treatment outside Section 280E on a prospective basis.

The federal action was limited. It did not broadly reschedule or deschedule all cannabis. Adult-use or recreational cannabis, as well as cannabis that is outside the qualifying state medical-license framework, generally remains a Schedule I controlled substance. Therefore, Section 280E continues to apply to adult-use cannabis activity unless and until a broader federal scheduling action takes effect.

This distinction is particularly important for businesses with both medical and adult-use operations. A company should not assume that a qualifying medical license removes Section 280E from all activities, all facilities or all revenue. The entity structure, applicable license, product and distribution pathway, and the factual connection between revenue and qualifying medical activity may all matter.

The MSO Refund Controversy

The limited 2026 relief should not be confused with the separate controversy over prior-year refund claims currently being litigated by the IRS. Beginning in 2023 and 2024, several multi-state operators (MSOs) filed amended federal income-tax returns taking the position that they could deduct ordinary business expenses previously barred by Section 280E. Trulieve, for example, reported receiving approximately $113 million in federal tax refunds related to amended returns. Those payments drew substantial attention throughout the industry, and many cannabis businesses filed amended returns believing that the refunds issued by the IRS were evidence that it was no longer enforcing 280E.

An issued refund, however, was not an IRS concession that Section 280E did not apply in the years at issue. The IRS subsequently stated in new guidance that taxpayers seeking refunds of taxes paid related to Section 280E through amended returns are not entitled to a refund or payment. That statement is consistent with the traditional federal position that cannabis remained a Schedule I substance during the earlier years, and that state-law authorization did not override Section 280E.

The government has now taken an affirmative enforcement step to claw back these refunds. In May 2026, the Department of Justice sued TerrAscend in the U.S. District Court for the District of New Jersey to recover approximately $8.36 million, plus interest, that the IRS had paid after TerrAscend amended its 2020 federal return. The government alleges that TerrAscend improperly claimed ordinary business deductions that Section 280E disallowed. TerrAscend disputes the government’s position, and the case remains pending.

The lesson for cannabis businesses is practical as well as legal. A refund issued through the administrative tax return amendment process does not settle existing substantive law nor is it a concession that the IRS has changed its posture on 280E. Prior-year claims may be audited, denied, challenged through deficiency procedures or pursued as alleged erroneous refunds. The status of an individual taxpayer’s claim will depend on the particular return position, applicable limitations periods, refund procedures, disclosures and factual record.

Prospective Relief Versus Retroactive Relief

For qualifying state-licensed medical-cannabis operations, the 2026 Schedule III action creates a strong case for prospective 280E relief. The practical implementation question is how Treasury and the IRS will address effective dates, registration requirements, mixed medical and adult-use businesses and expense allocation. Businesses should keep watch for formal agency guidance directly from the IRS rather than relying exclusively on industry commentary.

Retroactive relief is substantially less certain. The April 2026 action encourages Treasury to consider retrospective Section 280E relief for periods involving qualifying medical-cannabis licenses. It does not, by itself, establish a general right to amend earlier returns and recover tax paid under Section 280E. The federal government’s position in the TerrAscend litigation is plainly inconsistent with the proposition that a later scheduling development retroactively makes prior-year deductions allowable.

A taxpayer considering a prior-year filing should distinguish a protective refund claim from an affirmative amended return that asserts present entitlement to a refund. A properly drafted protective claim may preserve a refund right that depends on a specified future event, such as formal retrospective relief, a favorable judicial decision or new IRS guidance. But a protective claim does not eliminate the need to articulate a viable legal basis, comply with the applicable refund statute of limitations or manage the risk associated with a disputed tax position.

What Should Cannabis Businesses do in Response?

This is the million-dollar question. The U.S. Supreme Court affirmed in 2005 the federal government’s authority under the Commerce Clause of the Constitution to regulate cannabis, including in states that have legalized its use for medical and recreational (adult) use. See Gonzales v. Raich, 545 U.S. 1 (2005). The case also led to a notable dissent by Justice Clarence Thomas, who was specifically critical of the enforcement of 280E and the CSA on the sale and use of medical cannabis.

While the federal government continues to assess the reclassification of cannabis and the application of 280E, and while related litigation is ongoing, cannabis businesses should actively position themselves to take advantage of any favorable changes that may occur in the future. One important area where this is especially true concerns previously filed tax returns that comply with 280E. It is important to note that businesses generally have three years to amend their tax returns if they intend to claim a refund. It is generally not possible to claim a refund for tax returns filed more than three years ago.

In light of this fact, cannabis businesses should consider filing amended protective returns to preserve their ability to claim a retroactive refund for the 2023 tax year if the federal posture on 280E were to change. Filing a protective amended return with the IRS involves a process that allows taxpayers to preserve their right to a refund while awaiting the resolution of a contingent event.

In this case, the contingent event is the applicability of 280E to cannabis businesses. The process for filing a protective amended return is the following:

1. Identify the Basis for the Claim: Clearly identify the basis on which the protective claim for a refund or credit is filed. This involves specifying the contingent event is an expected change to the application of 280E.
2. Provide Sufficient Facts: Include sufficient facts to apprise the IRS of the underlying reasons for the claim. This should include a detailed description of the 280E ordinary business deduction and how it specifically affects the claim and the specific tax year or years involved.
3. Quantify the Refund, if Possible: If the amount of the 280E refund is known or can be reasonably estimated, quantify the amount of the expected 280E refund in your claim.
4. Filing Requirements: The claim must be in writing and signed and dated under penalty of perjury. While there is no specific form for filing a protective claim, you can use Form 1120-X, "Amended U.S. Corporation Income Tax Return," for corporations. Ensure that the document clearly states "Protective Claim" at the top of the first page.
5. Deadline for Filing: File the protective claim for the 2023 tax year before the expiration of the statute of limitations for claiming a refund on April 15, 2027. Amended protective returns for 2024 and 2025, if necessary, can be filed later.
6. Follow Up: After the 280E contingency is resolved, amend your protective claim as soon as practical to provide any additional required information or to formalize the claim based on the resolution. This will require close monitoring of the MSO cases and any changes to the legal landscape impacting 280E.
7. Administration by the IRS: Be aware that the IRS may hold a protective claim in abeyance indefinitely until the contingent event is resolved. The IRS has discretion in deciding how to process protective claims, and in general, it is in the interests of the IRS and taxpayers to delay action on these claims until the contingency is resolved.

By filing a protective amended return, cannabis businesses can preserve their right to claim a refund if 280E and its applicability to cannabis businesses should change in any way.

What May Happen Next

The most significant open question for the balance of 2026 and into 2027 is whether the U.S. Drug Enforcement Administration (DEA) completes a broader move of cannabis from Schedule I to Schedule III. The DOJ and DEA restarted an expedited administrative process to review cannabis scheduling in 2026, and a new DEA hearing began on June 29, 2026. As of Sept. 15, 2026, the broader scheduling process has not produced a final rule that applies to cannabis generally.

A final nationwide Schedule III rule would generally remove the statutory predicate for Section 280E prospectively, because Section 280E applies only to Schedule I and II substances. That could produce major tax relief for adult-use cannabis operators, particularly those that currently bear the most severe 280E burden. The timing, scope, effective date and durability of any broader action remain uncertain, however. A final rule could be delayed, narrowed, challenged in court or accompanied by transition rules that require careful tax analysis.

The limited medical-cannabis order remains in effect while related litigation proceeds. A court’s refusal to immediately block that action did not resolve the merits of the legal challenge or decide the separate broader DEA proceeding. Therefore, cannabis businesses should plan for multiple scenarios and not simply assume that 280E will disappear across the industry by year-end or at the start of 2027.

Section 280E has not gone away for the cannabis industry. Rather, 2026 has produced a more complex framework. Qualifying state-licensed medical-cannabis activity now has a strong basis for prospective relief because it has received Schedule III treatment. Adult-use cannabis businesses generally remain subject to Section 280E while cannabis remains Schedule I outside that limited framework.

The earlier MSO amended-return strategy remains unresolved and contested. Taxpayers should not infer from an issued refund that the IRS agrees with the underlying position, particularly now that the government has publicly rejected such refund claims and sought recovery from TerrAscend. Sound planning in 2026 requires disciplined documentation, careful separation of medical and adult-use activity, fact-specific tax analysis, and close attention to the rapidly evolving federal regulatory process.

For more information on Section 280E, refund claims, or tax planning in the evolving federal cannabis environment, contact a qualified tax professional.