Section 280E and Schedule C: What Changed for Medical Cannabis, What Did Not for Adult-Use, and How COGS Fits (2026 Guide)

Published: October 21, 2026 · Reading time: 13 min

TL;DR: Section 280E disallows deductions and credits for a trade or business that consists of trafficking in Schedule I or II controlled substances. Since April 28, 2026, marijuana in an FDA-approved product or subject to a state medical marijuana license is in Schedule III, so 280E generally stops applying to that medical-licensed activity going forward. Adult-use (non-medical) marijuana remains Schedule I, so an adult-use store can still lose rent, wages and advertising on Schedule C while cost of goods sold (COGS) is subtracted from sales first and survives. Earlier years are not automatically fixed, and we found no issued IRS guidance. In the adult-use worked example below, $70,000 of disallowed expenses lifts Schedule C profit from $50,000 to $120,000 and self-employment tax by about $9,890.68, before income tax. A freelancer who only provides services to a cannabis client is not automatically covered, but the edges are fact-driven, so confirm with a CPA or EA.

Most Schedule C advice assumes that if a cost is ordinary and necessary, you deduct it. Section 280E flips that assumption for one kind of business. Until this spring it reached essentially every state-legal marijuana seller. Since April 28, 2026 it reaches a narrower group, and the line is drawn by the type of license and product, not by whether the state allows the business.

This guide is for the freelancer or sole proprietor who is inside the cannabis industry, next to it, or deciding whether to work with it. It does not tell you how to structure a cannabis company or whether any position is safe; that is a conversation for a CPA or EA with experience in this area.

What Section 280E Actually Says

Section 280E of the Internal Revenue Code reads:

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.

Three phrases do the work. "No deduction or credit" reaches ordinary business expenses and credits. "Consists of trafficking in controlled substances" makes the test about the nature of the trade or business, and the parenthetical widens it to the activities inside the business. "Schedule I and II" borrows the Controlled Substances Act's schedules, so a substance in Schedule III is outside those words. That is the hinge of everything that changed in 2026.

The "prohibited by Federal law or the law of any State" language is why state legalization alone never ended the discussion: a federal prohibition by itself satisfies the statute.

Where Marijuana Sits Today: A Split Market

On April 28, 2026 the Drug Enforcement Administration published a final rule, 91 FR 22714 (FR Doc 2026-08176), titled "Schedules of Controlled Substances: Rescheduling of Food and Drug Administration Approved Products Containing Marijuana From Schedule I to Schedule III." Its DATES line reads "Effective April 28, 2026." We read the rule from the Federal Register's raw text, not from a summary.

The resulting regulation is 21 CFR 1308.13(g). In the eCFR text current as of October 19, 2026, paragraph (g)(2) reads "Marijuana, as defined in 21 U.S.C. 802(16), in a U.S. Food and Drug Administration approved product or subject to a state medical marijuana license." Paragraphs (g)(3) and (g)(4) use the same medical-license language for marijuana extract and for naturally derived delta-9-tetrahydrocannabinols.

The rule is explicit about everything outside those entries: "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." The eCFR text of 21 CFR 1308.11 still shows "Marihuana" as item (d)(23) of Schedule I on the same date, and 21 U.S.C. 812(c) still lists "Marihuana" as item (10) of Schedule I.

What the rule says about section 280E

The rule addresses 280E directly in two places. The Acting Attorney General's tax-implications section says: "as a consequence of this rule, state licensees will no longer be subject to the deduction disallowance imposed by Section 280E of the Internal Revenue Code." The Administrator's discussion says: "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."

The second version is the precise one: it is about holders of state medical licenses, which matches the regulation text. The first says "state licensees" without the word "medical," but it sits in a rule limited to FDA-approved products and medical licenses that says other marijuana stays in Schedule I. An adult-use-only license is not a state medical marijuana license.

Two more sentences belong in any tax plan. 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." That is an encouragement, not relief. And: "Nothing in this rule constitutes a determination regarding federal tax liability." The DEA is telling you which schedule applies, not how the IRS will treat your return.

What about adult-use marijuana?

DEA published a companion document the same day, 91 FR 22777 (FR Doc 2026-08177), a notice of a hearing on the proposed rescheduling of marijuana into Schedule III, to begin June 29, 2026. We searched the Federal Register through October 21, 2026 for a later final rule moving the remaining marijuana out of Schedule I and found nothing newer on marijuana scheduling than the three April 28 documents, so we found no final rule. Law-firm commentary from September 2026 says the hearing has concluded and a decision is pending; we have not verified that, and a search like this can miss things. Commentary also reports court challenges to the April rule; we did not verify any. Until a final rule says otherwise, section 280E applies to an adult-use business exactly as it did before.

What the IRS has and has not said

On April 23, 2026 the Treasury Department and the IRS published a press release titled "Treasury, IRS Announce Process for Tax Guidance Following DOJ Final Order on Medical Marijuana Rescheduling." As we read it, the release says:

• Rescheduling generally removes section 280E as a bar for businesses that, because of the order, no longer traffic in Schedule I or II substances.
• Guidance is expected to clarify how, for businesses with multiple activities, 280E applies only to the activities that still involve Schedule I or II substances, for example by apportioning expenses.
• Guidance is expected to include a transition rule under which rescheduling generally will be considered to first apply for the business's full taxable year that includes the effective date, for the activities that no longer involve Schedule I or II substances.

If that transition rule is issued as announced, a calendar-year medical licensee would be treated as outside 280E for all of 2026, not only after April 28. That is an announced plan, not a rule you can rely on yet, and the release does not describe relief for earlier years.

What we could not find: no notice or revenue procedure on 280E in the Internal Revenue Bulletins numbered 2026-17 through 2026-42 (the only marijuana mention was in the qualified tips regulations, a different subject), and no issued guidance in a web search, only the April 23 announcement and commentary saying nothing had been published. The IRS website's own search could not be queried from our tools, so we cannot rule out something posted elsewhere. Check IRS.gov before acting.

The Tax Court's Framing: Income Is Taxed, Deductions Are Not Allowed

The leading cases are Tax Court decisions on California medical marijuana providers from the early 2000s, decided while all marijuana was Schedule I. For medical licensees they are history for the period after April 28, 2026; they remain live authority for adult-use businesses and for earlier years.

Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007) (CHAMP). The taxpayer provided medical marijuana along with caregiving services. The court held that section 280E barred the deductions attributable to the marijuana but not those for the caregiving services, which it found to be a separate trade or business. It wrote that whether an activity is a trade or business separate from another "is a question of fact that depends on (among other things) the degree of economic interrelationship between the two undertakings," and that the caregiving business "stood on its own, separate and apart from petitioner's provision of medical marijuana."

Olive v. Commissioner, 139 T.C. 19 (2012). The taxpayer ran a San Francisco medical marijuana dispensary and filed a Schedule C reporting gross receipts, COGS and expenses for 2004 and 2005. The court held that he underreported gross receipts, that he could deduct COGS in amounts greater than the IRS allowed to the extent stated, and that he could not deduct his claimed expenses. The opinion also made the point this article turns on: "COGS is not a deduction within the meaning of sec. 162(a) but is subtracted from gross receipts in determining a taxpayer's gross income."

Neither case is a recommendation. They show the structure for a business still covered: the IRS taxes the income, section 280E strips the deductions, and the dispute moves to how much of a business's costs can be characterized as something other than a deduction.

Why Cost of Goods Sold Survives

If section 280E blocks "any deduction," how does anyone in this industry subtract anything? Because cost of goods sold is not in the deduction category. Treasury Regulation 1.61-3(a) defines gross income for a merchandising business as "the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources." COGS comes off sales before gross income exists, and Olive treated it as outside the word "deduction."

On Schedule C this is the same Part III any product seller uses. The 2025 Instructions for Schedule C say that in most cases, if the production, purchase or sale of merchandise was an income-producing factor in your business, you must take inventories into account at the beginning and end of your tax year. The result flows to line 4 and then gross profit on line 5. If you have never filled out Part III, start with the Part III walkthrough and the inventory and COGS guide for resellers. COGS works the same way for everyone; for a medical licensee no longer covered by 280E it is simply one cost recovery among several.

What goes into COGS, and what does not

Treasury Regulation 1.471-3(b) prices purchased merchandise at "the invoice price less trade or other discounts" (strictly cash discounts are treated differently) and includes "transportation or other necessary charges incurred in acquiring possession of the goods." That narrow definition is why purchases are the safest COGS. The right-hand column below describes a business still covered by 280E, such as an adult-use store; treat it as a starting point, not a position to take without advice.

The last row is not settled. Producers have more to argue about than pure resellers, because inventory costing rules for goods you make can pull some indirect production costs into inventory. How far that goes for a business covered by section 280E has been litigated, and we did not verify a current answer. If you make what you sell, that is the most valuable hour you can spend with a CPA or EA. For the small-business exception to the uniform capitalization rules, see the UNICAP small business exception.

Worked Example: What Section 280E Does to One Adult-Use Year

Sam is a sole proprietor, through a single-member LLC treated as a disregarded entity, who operates a state-licensed adult-use retail cannabis store. The store holds no state medical marijuana license and sells no FDA-approved drug product, so its marijuana is Schedule I and section 280E applies for the whole year. The numbers are round so the mechanics are easy to check:

Without section 280E (the way an ordinary retailer would file): $120,000 gross profit minus $70,000 of expenses leaves $50,000 of Schedule C net profit on line 31.

With section 280E (all four expense lines disallowed, COGS allowed): gross profit of $120,000 is the net profit, because nothing is left to deduct. Schedule C shows $120,000.

The disallowed $70,000 is 58.3% of gross profit. Sam's profit margin on sales goes from 16.7% to 40.0% even though nothing about the economics changed; the percentages come from the table (50,000 and 120,000 divided by 300,000, and 70,000 divided by 120,000).

The self-employment tax effect

IRS Tax Topic 554 says that generally the amount subject to self-employment tax is 92.35% of your net earnings from self-employment, and that the rate consists of 12.4% for Social Security and 2.9% for Medicare, which together make 15.3%. (The 92.35% figure comes from Tax Topic 554, not from the Schedule SE instructions.) The Social Security portion applies only up to the annual wage base, which IRS Publication 505 gives as $184,500 for 2026. Both of Sam's results stay below it once multiplied by 92.35% (the larger is $110,820), so the full 15.3% applies to both.

The difference is $9,890.68 of additional self-employment tax. The deduction for half of self-employment tax lowers income tax, not this self-employment tax figure, and the example ignores income tax entirely. We did not apply a bracket because the right marginal rate depends on the household, and picking one would turn a mechanics example into a tax-bill promise. The extra $70,000 of profit is taxed at your household's marginal rates on top of the self-employment tax above. For how that tax is built line by line, see the Schedule SE guide.

The same store with a medical license

Now change one fact: Sam's store operates under a state medical marijuana license. For the part of 2026 after April 28, that activity is in Schedule III, and both the DEA rule and the Treasury announcement say 280E generally no longer applies to it. If Treasury issues the transition rule as announced, all of 2026 could be treated as outside 280E; if not, January through April 27 is an open question. We do not put a second set of numbers on that, because it depends on guidance that has not been issued. For 2025 and earlier years the store would look like the adult-use column above, since the rule only encourages Treasury to consider retrospective relief and we found none. A store with both medical and adult-use sales is the hardest case: until Treasury's expected apportionment guidance arrives, how to split shared rent and wages is a question for a CPA or EA.

Is a Freelancer Who Serves Cannabis Clients Covered?

Many readers are not selling the product: a graphic designer for a dispensary, a bookkeeper, a photographer, a delivery driver contracted to a licensed carrier, a trimmer paid per pound. The statute turns on your trade or business, and the facts decide it.

• A designer whose only link is a dispensary client does not fit the words "consists of trafficking" on its face, whether the client is adult-use or medical-licensed. That is a reading of the text, not IRS guidance, and we found no IRS guidance resolving borderline roles.
• Whether two undertakings are separate trades or businesses is a question of fact. In CHAMP the caregiving services stood on their own, which helped that taxpayer. It is not a formula you can copy.
• A role that touches the product (buying, holding, selling or moving it as part of a sale) is closer to the statute's language. Which schedule the product is in now matters: work tied to adult-use product is still within the Schedule I words, while work tied only to product sold under a state medical license involves, going forward, Schedule III product. Employee or independent contractor status does not by itself answer the question.

If you do any product-touching work, write down your duties, which license the product moves under, who controls it, and how you are paid, and bring that to a CPA or EA.

The Instructions for Schedule C say that if you owned more than one business you complete a separate Schedule C for each. That is a reporting instruction; it does not decide whether you have more than one business. CHAMP's result rested on facts, and filing two forms over one business invites the argument that the split was artificial. That matters more now that apportionment between medical and adult-use activity is open. For the ordinary test, see multiple Schedule C businesses.

You Still Have to Report the Income

Section 280E limits what you can subtract. It does not let you leave income off, and rescheduling does not either. Publication 525 states that "Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Schedule 1 (Form 1040), line 8z, or on Schedule C (Form 1040) if from your self-employment activity."

A business that cannot support its receipts and its COGS has lost the one cost recovery the statute leaves; Olive decided an underreported gross receipts issue and a COGS issue in the same opinion. See how to report cash income on Schedule C and what records to keep for each Schedule C line.

If you filed earlier years deducting everything and now think section 280E applied, an amended return is one route. The IRS Criminal Investigation voluntary disclosure practice states that it "does not apply to taxpayers with illegal sources of income" and treats income "legal under state law but illegal under federal laws" as illegal source income for that purpose. See voluntary disclosure vs. an amended return. This is a live issue for adult-use years and for medical years before the change, so talk to a CPA or EA, and consider an attorney, before you file anything.

What Could Still Change

You will hear that rescheduling ended 280E. The accurate version has three parts.

1. For medical licensees, it ended for the covered activity going forward. How the IRS treats 2026 as a whole, and how mixed businesses split costs, depends on guidance Treasury has announced but, on our search, not issued.
2. For adult-use, nothing has changed yet. If a final rule later moves the rest of marijuana to Schedule III, it would apply from its effective date, and the same questions about transition years and apportionment would arise again.
3. Earlier years are not reopened by the schedule change itself. The year a transaction occurred governs. The Administrator encouraged retrospective relief for medical licensees, but encouragement is not a rule.

Common Mistakes

1. Assuming state legality ends the issue. Federal prohibition alone satisfies the statute. State law never removed an adult-use store from 280E, and the April 2026 change turns on the license and product type.
2. Treating the rescheduling as covering all state-legal cannabis. Only marijuana in an FDA-approved product or subject to a state medical marijuana license moved to Schedule III. Adult-use sales remain Schedule I.
3. Assuming relief reaches earlier years. Years before April 28, 2026 stay under 280E until Treasury acts, and a 2026 return depends on a transition rule announced but not issued when we looked.
4. Deducting rent and wages anyway. For a business still covered, a disallowed expense line is a deduction the IRS can remove, and an understatement can bring penalties; see accuracy-related penalties and Form 8275.
5. Calling everything COGS. Purchases and freight-in are on firm ground under Treasury Regulation 1.471-3(b); indirect overhead is not, and it is where examinations concentrate. Fines and penalties have their own rule, covered in deducting government settlements and fines, and COGS does not cure them.
6. Treating two Schedule C forms as two businesses. CHAMP rested on facts, not paperwork, and it is where a mixed medical and adult-use business will be tested first.
7. Forgetting self-employment tax or weak inventory records. Disallowed expenses raise the Schedule SE base, and for a covered business a missing count or invoice is a missing deduction; see COGS vs. supplies and Schedule C lines 33 and 34 on inventory valuation.
8. Relying on an old article, including this one. Check 21 CFR 1308.11 and 21 CFR 1308.13(g) on the filing date, and IRS.gov for the announced guidance.

How CentSense Helps

Under section 280E, the paper trail behind cost of goods sold carries the whole return, and under any apportionment rule a record of which cost belongs to which activity will matter too. CentSense helps freelancers keep that trail:

• AI receipt scanning: the free plan includes 10 AI receipt scans per month, and Solo ($5/month) adds unlimited scans, so supplier invoices, freight bills and other purchase records are on file with their dates and amounts.
• Expense tracking by category, so cost of goods sold purchases stay separate from rent, advertising and other operating costs.
• Mileage tracking for trips tied to your business.
• CSV export so your CPA or EA can review COGS and the operating expenses without reconstructing them.

CentSense does not decide whether section 280E applies to you or which costs belong in COGS; that analysis belongs with a tax professional.

Frequently Asked Questions

What is section 280E and who does it apply to?

Section 280E of the Internal Revenue Code disallows deductions and credits for a trade or business that consists of trafficking in Schedule I or II controlled substances prohibited by federal or state law. Since April 28, 2026, marijuana in an FDA-approved product or subject to a state medical marijuana license is in Schedule III (21 CFR 1308.13(g)), so 280E generally no longer reaches that medical-licensed activity going forward. Adult-use (non-medical) marijuana remains in Schedule I (21 CFR 1308.11(d)(23)), so 280E still applies to an adult-use seller. Earlier years and mixed businesses are unsettled, so ask a CPA or EA.

Can a cannabis business still deduct cost of goods sold under section 280E?

Generally yes, because cost of goods sold is not a deduction. Treasury Regulation 1.61-3(a) defines gross income of a merchandising business as total sales less the cost of goods sold, and the Tax Court in Olive v. Commissioner, 139 T.C. 19, treated COGS as subtracted from gross receipts rather than as a section 162(a) deduction while disallowing that dispensary's other expenses. That matters most for an adult-use seller, whose operating expenses remain disallowed; a medical licensee whose activity moved to Schedule III on April 28, 2026 generally stops losing them going forward. Which indirect costs belong in inventory is contested, so have a CPA or EA review it.

Does section 280E apply to freelancers who work for or with cannabis companies?

Not automatically. The statute asks whether your own trade or business consists of trafficking in Schedule I or II controlled substances, and a designer, bookkeeper or consultant whose only link is a dispensary client is not described by those words, whether the client is adult-use or medical-licensed. A role that involves buying, handling or selling adult-use product, which is still Schedule I, is riskier than a pure services role, and the edges are a question of fact. We did not find IRS guidance resolving borderline roles, so describe your duties to a CPA or EA.

Does a business that sells cannabis plus unrelated services lose all of its deductions?

Not necessarily. In Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007), a case about a medical marijuana provider decided while all marijuana was Schedule I, the Tax Court held that the caregiving services were a trade or business separate from the marijuana business. That history now matters most for adult-use businesses, which remain subject to section 280E, and for earlier years. Separateness is a question of fact, and filing two Schedule Cs does not create two businesses, so get professional advice before you split one.

Do I still pay self-employment tax if section 280E disallows my expenses?

Yes, and the base is larger. Self-employment tax is generally figured on 92.35% of net earnings from self-employment (IRS Tax Topic 554), at 12.4% Social Security plus 2.9% Medicare. In this article's adult-use example, $70,000 of disallowed expenses raises Schedule C profit from $50,000 to $120,000 and self-employment tax from $7,064.78 to $16,955.46, a difference of $9,890.68, before income tax. A medical licensee whose activity is no longer covered by 280E generally does not face that gap for the covered period. Ask a CPA or EA to figure your numbers.

Do I have to report income from cannabis sales that are illegal under federal law?

Yes. Publication 525 says income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Schedule 1 (Form 1040), line 8z, or on Schedule C (Form 1040) if from your self-employment activity. Section 280E limits deductions against that income; it does not remove the income. Adult-use sales remain Schedule I and medical-licensed sales moved to Schedule III on April 28, 2026, but neither changes the duty to report the income, so talk to a tax professional before correcting a past year.

Did the April 2026 rescheduling give medical cannabis businesses relief for 2025 and earlier years?

Not on the record we found. The DEA rule is effective April 28, 2026 and says holders of state medical marijuana licenses will no longer be subject to section 280E; the Administrator only encouraged Treasury to consider relief for earlier taxable years. Treasury announced planned guidance on April 23, 2026 with a transition rule for the year that includes the effective date, and we found no issued IRS guidance. Adult-use businesses are not covered by that rule at all, so their years remain under section 280E. Ask a CPA or EA before amending anything.

If marijuana is moved to Schedule III, does section 280E stop applying?

For marijuana in an FDA-approved product or subject to a state medical marijuana license, it has been in Schedule III since April 28, 2026 (91 FR 22714), so section 280E generally no longer applies to that activity going forward. Other marijuana, including adult-use, remains Schedule I; DEA noticed a hearing on rescheduling it (91 FR 22777), and we found no final rule through October 21, 2026. A change applies from its effective date, not automatically to earlier years. Check the current schedule and ask a CPA or EA.

Authoritative References

• 26 U.S.C. 280E, Expenditures in connection with the illegal sale of drugs
• 26 CFR 1.61-3, Gross income derived from business
• 26 CFR 1.471-3, Inventories at cost
• 91 FR 22714 (FR Doc 2026-08176), DEA final rule
• 91 FR 22777 (FR Doc 2026-08177), DEA notice of hearing
• 21 CFR 1308.13, Schedule III (eCFR)
• 21 CFR 1308.11, Schedule I (eCFR)
• 21 U.S.C. 812, Schedules of controlled substances
• Treasury press release, April 23, 2026
• IRS: Publication 525, Taxable and Nontaxable Income
• IRS: Publication 505, Tax Withholding and Estimated Tax
• IRS: Instructions for Schedule C (Form 1040)
• IRS: Topic no. 554, Self-employment tax
• IRS Criminal Investigation: Voluntary Disclosure Practice
• CHAMP v. Commissioner, 128 T.C. 173 (2007)
• Olive v. Commissioner, 139 T.C. 19 (2012)

Keep the invoices that prove your cost of goods sold. Start a free CentSense account, scan each purchase receipt with AI the day you pay, and export a clean CSV for your CPA at filing time.

This guide is general education for U.S. freelancers and sole proprietors filing Schedule C. It is not personalized tax or legal advice. Whether section 280E applies to a particular business, whether its marijuana is medical-licensed or adult-use, what counts as cost of goods sold, how related activities are characterized, and how rescheduling and forthcoming IRS guidance affect a given year all depend on specific facts and current law. Consult a qualified CPA, enrolled agent or attorney before filing.