Section 280E for Cannabis Businesses: Accounting, COGS and Deduction Rules Explained

When §280E applies, ordinary business expenses can receive very different tax treatment.

Expenses that would normally be considered under general business-deduction rules may be disallowed for affected activity.

Tax accounting for a cannabis business therefore needs to distinguish legitimate inventory costs from operating expenses instead of treating every cash outflow as though it has the same tax character.

The accurate answer is: it depends on the activity.

Qualifying medical-marijuana activity covered by the April 2026 federal action moved to Schedule III.

Other marijuana activity was not automatically moved with it, and broader marijuana rescheduling remains a separate proceeding.

The April 2026 action covers FDA-approved products containing marijuana and marijuana products subject to qualifying state-issued medical-marijuana licenses.

The scope of the federal order matters.

A business should not assume that every marijuana product or every state-authorized activity received Schedule III treatment.

The April medical-marijuana order did not automatically move state adult-use marijuana activity into Schedule III.

Where adult-use activity continues to involve a Schedule I substance and §280E’s other conditions are met, the provision can remain relevant.

Broader federal rescheduling should be monitored separately rather than assumed in advance.

COGS is part of the calculation used to determine gross income from merchandise sales.

In simplified terms, gross receipts are reduced by COGS before ordinary business deductions are considered.

IRS Chief Counsel has specifically distinguished this gross-income calculation from deductions disallowed by §280E.

A reseller generally looks to the applicable inventory-cost rules for the cost of merchandise acquired for resale and other qualifying inventory costs.

The goal is not to build the largest possible COGS number.

The records should show which costs actually belong to acquiring and holding inventory under the applicable method.

A producer’s analysis differs because production costs become part of the inventory question.

Direct materials, direct labor and qualifying production-related costs may be relevant under the applicable inventory rules.

Selling, administrative or other costs do not become production costs simply because recovering them through COGS would produce a better tax result.

A portion of a cost may sometimes support production, while another portion supports selling, administration or another function.

The account name alone does not determine the treatment.

The business needs a supportable connection between the cost, the work performed and the applicable inventory rule.

Section 263A should not be treated as a way to convert expenses otherwise disallowed by §280E into recoverable inventory costs.

IRS Chief Counsel specifically rejected that approach in its cannabis inventory memorandum.

Likewise, this guide does not treat §471(c) as a blanket authorization to expand cannabis COGS.

Any position should be evaluated against the current Code, regulations and guidance rather than used as an automatic tax shortcut.

The books should make the activities distinguishable without requiring a year-end reconstruction.

Revenue, inventory, direct costs and shared expenses should be captured with enough detail to support whichever allocation or apportionment method ultimately applies.

Treasury and the IRS have specifically identified multiple-activity expense apportionment as an area for guidance following the 2026 medical rescheduling.

A genuinely separate trade or business can require separate analysis, but the conclusion depends on the facts.

Creating a second legal entity, department or general-ledger account does not automatically remove §280E from activity that remains within its scope.

The underlying operations and records still need to support the distinction.

In tax accounting for a cannabis business, the supporting file should connect the tax treatment back to the actual business records.

Depending on the operation, that may include invoices, inventory records, production reports, labor or time support, allocation workpapers, reconciliation schedules, general-ledger detail and documentation showing how shared costs were assigned.

Current cannabis tax planning should start with accurate activity classification, supportable COGS, reliable inventory records, reconciled books and a clear understanding of which expenses belong to which operation.

For businesses with both medical and adult-use activity, the accounting should also be ready to support current Treasury/IRS guidance as it develops rather than waiting until filing season to recreate the underlying facts.