Cannabis §280E 2026 COGS vs Deduction Tax Calculator
IRC §280E denies federal deductions for businesses trafficking in Schedule I/II controlled substances — cannabis dispensaries can only subtract Cost of Goods Sold (COGS), not operating expenses. Effective federal rates often hit 60-90% of book income. The DEA's 2024 NPRM to reschedule cannabis to Schedule III would end §280E for 2026 plant-touching operators.
| Gross revenue | — |
| Less: COGS (allowed) | — |
| §280E gross income | — |
| Operating expenses (DISALLOWED) | — |
| Book income (GAAP) | — |
| Entity rate applied | — |
| Federal tax — §280E law | — |
| Federal tax — if Schedule III | — |
| Effective rate on book income | — |
IRC §280E denies federal deductions for businesses trafficking in Schedule I/II controlled substances — cannabis dispensaries can only subtract Cost of Goods Sold (COGS), not operating expenses. Effective federal rates often hit 60-90% of book income. The DEA's 2024 NPRM to reschedule cannabis to Schedule III would end §280E for 2026 plant-touching operators.
How §280E Works in 2026
IRC §280E (enacted 1982 after the Edmondson drug trafficking case) blocks any business "trafficking in controlled substances" from claiming deductions or credits — except COGS, which is constitutionally protected as a return of capital under the 16th Amendment. Champ v. Commissioner (128 T.C. 173, 2007) allowed allocation between dispensary operations and a separate caregiving business, but the IRS aggressively litigates segregation. For 2026, cannabis remains Schedule I federally, so every plant-touching dispensary, cultivator, processor, and vertically integrated operator pays tax on revenue minus COGS only — rent, payroll, marketing, utilities, and depreciation are all disallowed.
COGS Allocation Strategy
The biggest §280E lever is maximizing COGS inclusion. Treas. Reg. §1.471-3(c) defines inventory cost as direct material, direct labor, and indirect production costs. Cultivators can include cultivation labor, nutrients, grow utilities, and depreciation on grow equipment in COGS. Retailers have less room — only product cost and direct purchasing labor. Harborside Health Center v. Commissioner (151 T.C. No. 11, 2018) rejected aggressive COGS allocation for retailers, limiting them to §471(a) inventory rules. Producers fare better under §263A absorption costing — every dollar moved from "operating expense" to "COGS" saves 21-37 cents in federal tax.
DEA Rescheduling Impact for 2026
The DEA's Notice of Proposed Rulemaking (89 FR 44597, May 2024) proposes moving cannabis from Schedule I to Schedule III. Schedule III substances are not subject to §280E. If finalized in 2026, plant-touching operators would immediately deduct rent, payroll, marketing, and other ordinary §162 expenses — federal tax drops from 60-90% effective to 21-37% on book income. The proposal does not legalize cannabis federally and does not affect state legality. Final rule expected late 2026 or 2027 after administrative law judge hearings. Operators should model both scenarios for capital planning.
State Decoupling and Tax Planning
Most cannabis-legal states decouple from §280E — California (R&TC §17209), Colorado, Oregon, Massachusetts, New York, Illinois, and Michigan allow full state-level deductions. New Jersey and Washington partially follow §280E. Federal §280E still applies regardless of state law. Common planning: (1) Separate plant-touching from ancillary entities (security, IP licensing, real estate) so non-trafficking entities deduct normally. (2) Maximize §263A absorption for producers. (3) Use C-Corp structure to avoid passthrough rate exposure on disallowed deductions. (4) Document caregiving / non-cannabis lines aggressively. Audit risk is extreme — IRS Office of Chief Counsel issued ILM 201504011 confirming §280E applies to state-legal cannabis.
Last updated May 2026. Sources: IRC §280E, Champ v. Comm. 128 T.C. 173, Harborside v. Comm. 151 T.C. No. 11, DEA NPRM 89 FR 44597 (2024), Treas. Reg. §1.471-3(c).