On Dec. 18, 2025, President Donald Trump signed an Executive Order instructing the Federal Government to accelerate the rescheduling of cannabis from a Schedule I to Schedule III narcotic. Rescheduling is not full legalization, but it will have major implications for industry stakeholders, opening the door to tax deductions and credits previously disallowed under Section 280E. The impact of rescheduling to the cannabis industry will be vast, but not without its speed bumps.

The new motion on rescheduling makes this an optimal time to explore what tax compliance will look like when the DEA reschedules cannabis as a Schedule III drug.

Internal Revenue Code (IRC) Section 280E states that “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.”

Put simply, this means that any person or company selling cannabis while the DEA has it listed as a Schedule I drug is unable to take deductions for its selling, general, and administrative (SG&A) costs and can only deduct cost of goods sold (COGS). Section 280E does not differentiate between illicit operators and state licensed cannabis companies that are required to follow all the rules and regulations of the state in which they operate. The result is that many companies have large book (GAAP) losses, but, with SG&A expenditures disallowed as a deduction for tax, large taxable income, as well.

If cannabis is rescheduled and Section 280E no longer applies to the cannabis industry, income tax liabilities for plant-touching businesses will be significantly reduced. Many also – albeit incorrectly – believe that their income tax compliance will become more straightforward. In reality, Section 280E allows for shortcuts in the tax world, as the deductions and benefits related to items that will ultimately fall to Section 280E are not allowed. If cannabis is rescheduled, it will enable those in the industry to avail themselves to many tax credits, benefits, and various compliance burdens that were previously disregarded.

Interest expense

Many cannabis companies have significant debt financing. Interest expense is not a component of COGS and therefore is nondeductible under Section 280E. This means that these companies were not affected by the interest expense limitation under IRC Section 163(j) because these interest expenses were already being disallowed under Section 280E.

However, when Section 280E no longer applies, the limitations under Section 163(j) will have to be considered. The interest expense limitation allows a deduction for interest expense only to the extent of 30% of adjusted taxable income, a defined term. This will likely result in interest expense limitations – a temporary book to tax difference – meaning any amount disallowed can be carried forward and used to the extent that there is adjusted taxable income in a subsequent year.

Research and development (R&D)

Cannabis is a research and development intensive industry. Under the One Big Beautiful Bill Act (OBBB), companies may once again deduct domestic specified research and experimental (SRE) expenditures as paid or incurred. Under the Tax Cuts and Jobs Act, such expenses were required to be capitalized and amortized over five years. Foreign SREs are still required to be capitalized and amortized over 15 years under the OBBB. In practice, most cannabis companies operating within the U.S. do not have foreign R&D, so this is generally not an issue.

When Section 280E no longer applies, you will be allowed to take advantage of the R&D credit. R&D credits can reduce your income tax liability and, sometimes, your payroll tax liability. Typically, the value of the credit can be 5-10% of actual domestic R&D expenses, the largest single cost of which is typically salaries.

Inventory

If your average gross receipts in 2025 over the prior three-year period totaled $31 million or greater, you are subject to the Uniform Capitalization Rules (UNICAP) under IRC Section 263A. UNICAP was previously not as important to cannabis companies because all indirect costs were disallowed under Section 280E. However, if Section 280E no longer applies, you would be required to capitalize a portion of your indirect expenses as they relate to inventory. These costs would then be deducted via cost of goods sold as inventory is sold over time. UNICAP can be a burdensome calculation and generally requires someone with specific knowledge and expertise.

Fixed assets/buildings/energy credits

Under Section 280E, taking bonus depreciation is not allowed. With Section 280E gone, you will need to strategize when to take bonus depreciation and when to place fixed assets in service. To maximize fixed asset deductions, it may be beneficial to have a specialist perform a cost segregation study/fixed asset review. A cost segregation study enables you to reclassify more fixed assets into shorter-term depreciation categories, allowing you to recover costs faster than if they were depreciated over longer periods – such as 15 years for leasehold or land improvements, or 39 years for buildings. Given all the potentially unfavorable book-to-tax differences, maximizing your fixed assets deductions would be important. If you are considering placing a facility into service during the year, it would be beneficial to place this facility in service after the rescheduling.

Furthermore, cannabis is an energy-intensive industry, so it is a good time to start exploring the applicability of renewable energy credits. These credits can apply to energy generated by renewable energy resources, such as solar or wind powered facilities. The tracking of renewable energy can be cumbersome but can result in significant income tax savings.

Labor

Cannabis is also a labor-intensive industry. Previously, much of your accrued bonus, vacation, wages, and commissions were allocated as SG&A costs and were therefore disallowed under Section 280E. If cannabis is rescheduled, these same costs will be subject to IRC Section 461, which can limit the deductibility of various wages from year to year as a temporary book-to-tax difference. Some of these indirect labor costs also may be subject to UNICAP as mentioned above.

The good news is that there will be certain credits for which you may be eligible. The Work Opportunity Tax Credit (WOTC), for example, can be a significant credit in labor intensive industries. You may be able to claim the WOTC if you hire employees who are in a WOTC-targeted group.

Net operating losses

Let’s say that, despite all these potential changes we have discussed, you were still generating taxable losses. We have seen a limited number of cases where prices declined so rapidly that operators sold product for less than the actual cost of acquisition or production.

For C corporations, these losses need to be tracked, and it is important to pay attention because a change of ownership may limit future credits. If there has been a change in ownership, net operating loss and credit limitations can come into play under IRC Section 382 and 383, respectively. A study of Sections 382 and 383 would be required to determine if there has been a change in ownership, and calculations would need to be done to determine exactly how limited your losses and credits were.

Other considerations

• We do not yet know how the IRS will handle the likely rescheduling. There is a possibility they will allow the Section 280E applicability to be retroactive to the start of the year, but this remains unknown. If they do not address the issue, it would be beneficial to incur more SG&A costs in the second part of the year.
• Our assumption is that any rescheduling will be solely on a prospective basis, except for the potential to apply to the beginning of the current tax year.
• We have mentioned just a few potential credits above, but there are other state credits that should be explored and considered with rescheduling.
• Rescheduling may require accounting method changes to be filed with the IRS, and method change tax planning strategies should be explored.
• Organizational structures commonly used within the cannabis industry in the past may no longer be advantageous and should be reviewed upon rescheduling.
  
  

The bottom line

Rescheduling of cannabis as a Schedule III drug will almost certainly increase a cannabis company’s cash flow. Will it simplify a cannabis company’s income tax filings? Not a chance.

Contact our team to discuss how potential changes in cannabis regulation could impact your business’s taxation, and what you can consider now to prepare.