Does 280E Still Apply in 2026? Medical vs. Adult-Use Cannabis After Schedule III

Does 280E Still Apply in 2026?

Short answer: California cannabis operators should continue to treat IRC 280E as applicable to plant-touching activity unless they have a documented, professionally supported basis for a different federal position. Rescheduling discussion has changed the conversation, but it has not produced settled federal tax treatment covering every operator, every line of activity and every open tax year. Anyone telling you the section is simply gone is describing a conclusion, not the current record.

Section 280E disallows deductions and credits for a trade or business consisting of trafficking in controlled substances listed in Schedule I or Schedule II of the Controlled Substances Act. Two features of that language matter in 2026. First, it keys to federal scheduling — not to whether a state calls a sale medical or adult-use. Second, it disallows deductions but has never disallowed cost of goods sold, which is why inventory accounting has always carried the weight in cannabis tax computation.

What that means practically is that operators should not assume all cannabis activity automatically receives identical federal tax treatment. A single California license holder can have medical sales, adult-use sales, non-plant-touching revenue, and shared overhead serving all three. If federal treatment ever diverges between those activities, the divergence will be computed from the books — and books that cannot separate the activities cannot produce the computation.

• Established: 280E has been applied by federal courts to state-licensed cannabis businesses, medical and adult-use alike; COGS has remained allowable subject to the applicable inventory-costing rules.
• Changed: the federal scheduling posture and the surrounding policy environment are in motion, which is why the question is being asked at all.
• Unresolved: how and when any change applies to specific taxpayers, whether prior or open years are affected, how amended returns or accounting-method changes would be handled, and how shared costs would be allocated between activities receiving different treatment.
• Needs guidance: Treasury and IRS direction on timing, transition, inventory-costing interaction and substantiation expectations. None of that should be assumed or invented in advance.
• Available now: preparation — clean books, segmented revenue, substantiated inventory and COGS, and documented allocation of shared costs.

Medical vs. Adult-Use Cannabis: Why the Difference Matters for 280E

California's commercial cannabis market runs medical and adult-use activity through a single regulatory framework administered by the Department of Cannabis Control, with licenses designated M (medicinal) or A (adult-use). Many operators hold both designations and run them out of the same premises, the same staff and the same inventory system. That structure is the reason this question lands harder in California than in states with fully separate medical and recreational programs.

State licensure has never created a federal tax exception: federal courts applied 280E to medical operators long before adult-use sales existed. So the medical/adult-use distinction has not historically been a federal tax distinction. What it has always been is an accounting distinction, and California makes that concrete:

• Qualified patients holding a state Medical Marijuana Identification Card are treated differently for California sales tax on medicinal cannabis purchases, so the point of sale must already capture and prove the designation.
• Medicinal and adult-use inventory is tracked with its own designation in the state's track-and-trace environment, which means the segmentation already exists upstream of the ledger.
• Medical activity often carries different pricing, purchase limits, product mix and margin, so blending it into one revenue account destroys information the operator needs anyway.
• Cannabis excise tax administered by the CDTFA applies to retail cannabis sales regardless of designation, so excise reporting and medical designation are separate data points that must both be preserved.

If any future federal guidance ever draws a line between categories of activity, the operators positioned to respond are the ones whose systems already report those categories separately. Operators who cannot do that would be reconstructing a year of transactions under time pressure. See our cannabis tax preparation and METRC reconciliation services for how that reporting is built.

The Mixed-Use Cannabis Accounting Problem

Consider a Sacramento retailer holding both M and A designations. Roughly a fifth of its revenue is medicinal sales to MMIC patients and qualified patients; the rest is adult-use. It also sells accessories and branded apparel, subleases a back suite to an unrelated tenant, and pays one general manager who supervises everything. One lease, one payroll, one security contract, one point-of-sale platform, one insurance policy.

Today, the federal computation does not depend on splitting those activities by designation. If federal treatment ever differs by activity, almost every line on that operator's income statement becomes an allocation question — and the allocation will be judged on the records that existed when the cost was incurred, not on a spreadsheet built afterward. That is the mixed-use problem: the tax question may be unresolved, but the bookkeeping consequence is entirely within the operator's control right now.

The elements that need to be separable:

• Revenue segmentation. Medicinal versus adult-use cannabis revenue, plus non-cannabis revenue such as accessories, apparel, delivery fees and rental income, each in its own account rather than one "Sales" line.
• Departments and classes. Retail, delivery, cultivation, manufacturing, distribution and administrative functions tagged in the general ledger so a report can be produced by activity without manual rework.
• Chart of accounts. A structure that anticipates segmentation instead of one added in a hurry later. Our cannabis chart of accounts template and sample shows a workable account structure.
• Direct expenses. Costs traceable to one activity — medicinal packaging, a delivery vehicle, a dedicated budtender shift — coded to that activity at entry.
• Indirect and shared expenses. Rent, utilities, security, software, insurance, professional services and management compensation, which serve everything and therefore need a stated basis of allocation.
• Payroll. Hours captured by function where practical — production, retail floor, delivery, administration — rather than allocated by a year-end estimate. See cannabis payroll.
• Inventory and COGS. Perpetual inventory tied to purchase documentation, with costs capitalized under the applicable inventory-costing rules for the license type, and the resulting COGS traceable to specific units sold.
• POS and track-and-trace records. Point-of-sale detail, METRC manifests and transfers, and the general ledger reconciling to one another for each period.
• Contemporaneous documentation. Invoices, timesheets, floor plans, usage logs, allocation memos and month-end workpapers created when the transaction happened.

One caution worth repeating: no IRS-approved allocation methodology for splitting cannabis costs between differently-treated activities has been published, and this guide does not offer one. What is defensible is a reasonable, consistently applied, documented method that reflects how the business actually operates.

Cannabis 280E Expense Allocation and Apportionment

Shared expenses are where the money is. In a typical California dispensary, rent, payroll, security and management compensation dwarf the costs that are cleanly traceable to one activity. If those costs ever have to be apportioned between activities with different federal treatment, the apportionment basis becomes the single largest judgment in the return.

• Rent. Track by location and, where a facility serves multiple functions, by square footage with a dated floor plan behind the measurement.
• Payroll and management. Track by role and hours by function; supervisory time that genuinely spans activities should be documented as such rather than assigned arbitrarily.
• Security. Contracts often cover the whole premises; note which areas and functions the coverage protects.
• Utilities. Sub-metering is ideal, especially for cultivation and manufacturing; where it does not exist, use a documented usage or square-footage basis.
• Software. Seat counts and module usage by department are usually available directly from the vendor invoice.
• Insurance. Policies frequently schedule locations and operations, which gives a natural allocation basis.
• Professional services. Ask advisors to bill by matter or activity; a single undifferentiated invoice is the hardest cost to allocate later.
• Shared facilities. Common areas, loading docks and vaults serve multiple activities and should be identified in the allocation policy rather than assumed away.

The through-line is contemporaneous documentation. An allocation supported by timesheets, floor plans, meter readings and invoices that existed during the year is a different object from a percentage produced after an examination begins. Nothing in this section promises that any allocated expense will be deductible — it will not be deductible unless the underlying tax treatment permits it — but an undocumented allocation forecloses the argument entirely.

Chart of Accounts After Schedule III

The right response to an unsettled tax environment is not to restructure the ledger around a position nobody can yet support. It is to add segmentation that improves the books under every possible outcome. Practically, that means the accounting system should be able to distinguish:

• medicinal cannabis revenue from adult-use cannabis revenue, by location;
• cannabis revenue from non-cannabis revenue such as accessories and merchandise;
• inventory by category, with adjustments for shrink, waste and count variance posted to visible accounts;
• cost of goods sold by product category and, where relevant, by activity;
• payroll and labor by function, separating production labor from selling and administrative labor;
• shared overhead in its own accounts, so allocations operate on identifiable pools rather than on mixed balances;
• departments, classes and locations as reportable dimensions;
• monthly reconciliations of bank, POS, track-and-trace and inventory to the ledger;
• supporting workpapers stored alongside the period close.

This is ordinary good accounting that happens to be well positioned for a change in federal treatment. Our cannabis bookkeeping and financial reporting services implement it, and the cannabis bookkeeping guide explains the monthly discipline behind it.

Inventory and COGS Still Matter

Every plausible version of the future computes taxable income from inventory. Under current treatment, cost of goods sold is the mechanism that keeps a plant-touching business from being taxed on gross receipts; under a different treatment, inventory costing still determines when a cost hits the income statement. Weak inventory records are a problem in either world.

• Perpetual inventory maintained in the operating system and reconciled to physical counts on a stated cadence.
• Costs capitalized consistently with the inventory-costing rules applicable to the license type — a cultivator, a manufacturer and a retailer do not capitalize the same costs.
• Purchase documentation, manifests and vendor invoices tied to the units received.
• Waste, destruction and shrink recorded in identifiable accounts rather than buried in product cost.
• Track-and-trace balances reconciled to the ledger every period.

For the mechanics, see our 280E and COGS guide, the cannabis cost accounting service, and METRC reconciliation practice. Cultivators and manufacturers should also read cultivation accounting and manufacturing accounting, where capitalization decisions are more consequential than at retail.

Documentation and Audit Defense

A changing federal tax environment makes clean accounting more important, not less. Positions taken in a period of transition attract scrutiny, and the records that support them have to be the ones created at the time. The file that holds up is usually assembled monthly, not annually.

• POS reports by day, by designation and by product category;
• track-and-trace records, manifests and transfer documentation;
• payroll registers with hours by function and job classification;
• vendor invoices matched to receipts and inventory entries;
• physical inventory counts with variance explanations;
• allocation workpapers showing the basis, the data and the calculation;
• written accounting policies, including the allocation policy and its effective date;
• supporting schedules for COGS, inventory rollforward and tax liabilities;
• monthly reconciliations of bank, POS, inventory and the general ledger.

Our audit representation service and the audit preparation guide describe what an examination actually asks for, and the California cannabis financial compliance guide ties the recordkeeping obligations together.

What California Cannabis Businesses Should Do Now

None of the following requires taking a tax position, and none of it depends on how the federal question resolves. All of it is preparation that a California operator can complete this quarter.

• Close the books monthly. A ledger closed within a couple of weeks of period end is the precondition for everything else.
• Separate medicinal and adult-use revenue in the POS and the ledger. California systems already carry the designation; make sure it survives the export into accounting.
• Preserve MMIC and patient documentation supporting the sales-tax treatment applied to medicinal transactions.
• Reconcile inventory to METRC and to physical counts on a stated schedule, with variances explained in writing.
• Document shared costs — rent by square footage, utilities by usage, payroll by function — with a written allocation policy applied consistently.
• Keep payroll detail at the function level, not just at the employee level.
• Preserve source documentation for the full statutory retention period, including manifests, invoices, contracts and count sheets.
• Keep state obligations current — CDTFA excise and sales tax filings, DCC license conditions and local cannabis business tax where the city or county imposes one. Federal developments do not change these.
• Be ready to implement guidance, not to anticipate it. Ask what would have to change in your system if treatment shifted mid-year, and build that capability now.

Operators in specific markets can start with our local pages for Los Angeles, San Francisco, Sacramento and San Diego, where local cannabis business taxes differ meaningfully.

Questions California Cannabis Operators Should Ask Their CPA

• Does 280E currently apply to all of our activity, or only part of it?
• Can our accounting system distinguish medicinal from adult-use activity without manual rework?
• How are shared expenses tracked today, and on what basis are they allocated?
• Is payroll tracked by actual function and hours where that matters?
• Can our inventory balances and cost of goods sold be substantiated to source?
• Do POS, METRC and accounting records reconcile every period?
• What documentation supports our current accounting treatment?
• What would have to change in our accounting if additional federal guidance is issued, and how quickly could we implement it?
• Which of our positions depend on unresolved federal questions, and how are those disclosed and documented?

For the commercial side of this work — planning, cost segregation, return preparation and examination support — see 280E tax compliance, dispensary accounting and fractional CFO advisory. Background reading: 280E explained and the California cannabis tax guide.