If cannabis does not meet the definition for a Schedule I, II, or III substance, then it is no longer a Schedule I, II, or III substance and 280E will no longer apply, regardless of formal classification.
Calyx, by Justin Botillier
Cannabis industry watchers know that the federal rescheduling will allow companies to deduct their ordinary business costs on tax returns. What if the cannabis industry didn’t need to wait until the federal rescheduling was finalized to achieve fair tax treatment on par with other businesses?
The IRS (Internal Revenue Service) has a rule called 280E that denies marijuana businesses the right to deduct their ordinary expenses. Sometimes, this can result in unsurmountable taxes. It is vital to understand what the code of taxation actually states. It prohibits any deductions from “any trade or business which”The term “trafficking” is used to describe the trafficking of controlled substances, as defined in Schedules I and 2 of the Controlled Substances Act.“
Congress selected the phrase “The term “adequate” is used in the sense ofInstead of simply being “listed as”, a Schedule I substance or II, “” is preferred. The subtle difference opens up a powerful argument. If cannabis does not meet the definition of Schedule I or Schedule II substances, then 280E is no longer applicable, no matter what its formal classification.
Now, the federal government is working to remove cannabis from the Schedule I Drugs list (a group reserved for dangerous drugs like heroin with “no recognized medical benefits”).
In late August 2023, the Department of Health and Human Services (HHS), relying on input from the Food and Drug Administration (FDA) and the National Institute on Drug Abuse (NIDA), officially recommended that cannabis be moved to Schedule III of the Controlled Substances Act (CSA). The recommendation came after a formal scientific review that concluded marijuana clearly “meets the three criteria for placing a substance in Schedule III.”
HHS determined that marijuana has lower abuse potential than Schedule I or Schedule II drugs. Cannabis is also accepted for medical purposes and has only moderate dependence risks. Schedule III substances have these characteristics.
This conclusion is not only reached by health agencies. Office of Legal Counsel of Department of Justice issued a legal opinion on April 20, 2024 that supported a much more reasonable standard for the accepted medical uses of a medication. OLC concluded that DEA’s existing method of evaluating “currently acceptable medical use” is “impermissibly limited,” and endorsed HHS’s two-part investigation as a basis for recognizing a medical use.
There is some ambiguity regarding the “bindingness” of HHS’s rescheduling recommendations on DEA. OLC stated in its opinion that “HHS determinations are bounding You can also read more about DEA initiates formal rulemaking, but it still must give HHS’s scientific and medical determinations significant deference.” The legal language of the Controlled Substances Act provides that the HHS secretary’s scientific and medical findings are conclusive for scheduling decisions; DEA cannot overrule HHS on those points.
This means that DEA cannot ignore HHS findings that cannabis is a medicine and has a lower potential for abuse. DEA is still working on rescheduling but it must incorporate HHS’s findings.
The OLC memo contains some ambiguity regarding whether HHS’s recommendation will be legally binding when rescheduling begins. However, it is important to note that HHS has acknowledged, alongside FDA, NIDA, and DOJ, that cannabis does not fit the criteria of Schedule I or 2. This recognition raises questions regarding the applicability and future of 280E.
Despite this change of expert opinion, IRS insists that 280E remains in effect until the DEA changes cannabis’s Schedule I classification.
IRS reminded cannabis companies that, in mid-2024 when they began claiming refunds for taxes paid previously, nothing had changed legally “regarding the classification or schedule of marijuana.” The agency flatly stated that amended returns seeking refunds of 280E taxes “are not entitled to a refund…these claims are not valid,” and warned it is taking steps to stop them. In IRS’s view, as long as cannabis is listed as Schedule I, 280E applies—period. This strict approach ignores the precise language of 280E. Deductibility is tied to Schedule I and II, not just the label.
It is a form-over-substance argument to insist that 280E is still applicable because the DEA has not yet issued its final rescheduling ruling. Like any other law, tax law must be read in its context. Congress could have stated that it intended 280E’s sole basis to be a DEA schedule label. Instead, they referred to the Controlled Substances Act criteria.
The IRS has not been able to help the industry reduce the burden 280E by using legal means.
Allow me to reintroduce Internal Revenue Code Section 471(c), enacted under the Tax Cuts and Jobs Act of 2018. This provision allows small businesses that qualify, with gross revenues under $29 million, to utilize inventory accounting systems in accordance with their own records and books. Cannabis operators are able to classify an even wider range of costs, such as facility rent, payroll and other expenses. When properly capitalized these expenses become part of cost of goods and are therefore deductible even under 280E.
In 2021, however, IRS issued regulatory “guidance” stating that 471(c) could not be used to deduct expenses that were “otherwise disallowed” by another section of the tax code, effectively attempting to block cannabis operators from using it to mitigate 280E, which successfully deterred most accountants from using the method for years. The IRS guidance wasn’t based on court precedent or statutory laws; rather, it was an interpretation of the regulatory code meant to limit a valid provision. It is not clear in the regulation that cannabis businesses are prohibited from using section 471(c) and so many tax professionals still rely upon it to be a conservative and defensible approach. This is a practical way to lower tax liabilities for “smaller operators” with gross receipts under $29 millions.
It is worth mentioning that IRS’s enforcement actions often contradict its strong-worded warnings. IRS can choose to not prosecute a return that is filed in good-faith by an experienced professional and is based on reasonable interpretations of the tax codes. IRS, despite being warned about the potential for a 471c strategy to be challenged in court, has chosen not to do so.
The opportunity to correct past returns, seek refunds, or amend them is not risk-free, but for many, it could provide a significant amount of relief. Some may decide to simply move on, leave the past behind, and prepare returns going forward without compliance. Both options are brave. Many may decide that the risks are worth it if they have a sound tax strategy, backed by professionals, and weigh the cost against any future overpayments.
Justin Botillier, co-founder of Calyx CPA and its CEO, is a specialist in accounting, taxation, and business consultation for the cannabis, and psychedelic, industries. Justin Botillier and his team, who have over 20 years of taxation experience and more than a decade of serving the cannabis and psychedelic industries, helped their clients to save millions by using aggressive and defendable strategies that mitigated the effects of the 280E.
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