Key Takeaways
-
Potential rescheduling of marijuana to Schedule III under the Controlled Substances Act (CSA) could remove Internal Revenue Code Section 280E limits, allowing cannabis companies to deduct expenses and lower effective tax rates.
-
Eliminating Section 280E exposure may require cannabis companies to reassess entity structures, amended returns and Accounting Standards Codification 740 (ASC 740) tax positions, deferred tax assets and effective tax rate calculations.
-
Schedule III status may ease banking access and capital participation while cannabis companies still face state regulation, licensing rules and heightened scrutiny of controls, compliance and financial reporting.
A federal effort to move marijuana from Schedule I to Schedule III under the Controlled Substances Act (CSA) could significantly reshape the financial landscape for cannabis companies. If finalized, rescheduling would remove marijuana from the scope of Section 280E — a tax provision that has long disallowed ordinary business deductions for operators — potentially reducing effective tax rates and altering entity structures, financial reporting considerations and access to capital. While the change would not constitute federal legalization, it represents a critical planning moment for the industry.
Breaking it Down
The executive order, Increasing Medical Marijuana and Cannabidiol Research, directs the Drug Enforcement Administration (DEA) to continue a rulemaking process that began under the previous administration. The Attorney General and relevant federal agencies will complete it. While timing is uncertain, finalization could take months and may be extended by process delays or legal challenges.
If you run a cannabis business, you already know the tax burden is unlike any other industry. That burden comes from a provision in the tax code called Section 280E, which disallows deductions or credits in determining taxable income if a business sells controlled substances – those on Schedule I or II under the CSA, such as marijuana. That means that marijuana businesses are effectively taxed on their gross income.
Section 280E also limits the expenses cannabis companies can deduct against their taxable income. As a result, the effective tax rates for a cannabis business can exceed 70 percent, while a non-cannabis corporation averages an effective tax rate of around 28 percent.
What This Means for Your Cannabis Company
If marijuana is rescheduled as a Schedule III controlled substance, cannabis businesses can bypass the Section 280E expense limitations. That single change would transform the financial picture for cannabis companies. It is important to emphasize that the order is, itself, not the reclassification required to move marijuana to Schedule III. The IRS in the past has emphasized this with prior proposed rulemaking.
While that shift would be significant, it would not amount to federal legalization. Cannabis would remain federally regulated, continue to operate under state licensing frameworks and stay subject to changing enforcement priorities. While access to banking, capital markets and interstate commerce could improve over time, those developments would likely unfold gradually rather than all at once.
State tax treatment also deserves close attention. Federal changes do not automatically flow through to the states. Some jurisdictions may continue to decouple from federal rules, requiring multi-state operators to evaluate tax exposure on a state-by-state basis.
Next Steps for Cannabis Companies if the Shift from Schedule I to III Occurs
Your tax structure could change. Many cannabis businesses built complex entity structures specifically to manage Section 280E exposure. If rescheduling goes through, those structures may change or no longer be necessary. Simplifying them could reduce overhead and administrative burden — but unwinding entities can trigger tax, regulatory and licensing consequences. See our recent article, The Restructuring Decision.
If rescheduling becomes effective, companies will need to reassess existing tax positions from both a compliance and financial reporting standpoint.
From a tax-return perspective, cannabis businesses have historically taken different approaches under Section 280E. Some have filed conservatively, while others have submitted amended returns excluding 280E based on a reasonable basis standard. A change in scheduling would require companies to evaluate the effective date of the change, its impact on open tax years, whether prior positions remain supportable and whether amended returns, refund claims or accounting method changes are appropriate.
From an ASC 740 financial-reporting standpoint, companies will need to reassess the recognition and measurement of uncertain tax positions under the more-likely-than-not standard. Eliminating 280E exposure could materially affect:
- Deferred tax assets and liabilities
- Valuation allowances
- Effective tax rate calculations
- Interest and penalties accruals
A change in tax law or regulatory status may also represent a discrete event requiring remeasurement in the period of enactment. Companies should evaluate whether adjustments are recorded through continuing operations and determine the appropriate financial statement disclosures.
Both public and private companies preparing for financing or transactions should work closely with tax advisors and auditors to assess the financial reporting impact, documentation requirements, internal controls and related disclosures.
Banking access improves. Rescheduling may ease certain banking constraints, though it would not rewrite existing banking laws or eliminate regulatory uncertainty. A move to Schedule III could reduce the perceived legal and reputational risk for financial institutions, which in turn may encourage more banks, lenders and private equity groups to reenter the space. Companies that maintain strong compliance programs and clear financial reporting will be better positioned to benefit from broader banking relationships and potentially lower transaction costs.
This is a planning moment. Rescheduling could be one of the most significant financial shifts this industry has experienced. Increased after-tax liquidity may drive industry consolidation, as the additional liquidity could lead robust firms to seek strategic acquisitions, while others may prioritize corporate restructuring. Boards and management teams should use this time to reassess long-term strategy, capital structure and operational scalability to ensure they are positioned for growth in a post-Section 280E environment.
Risk Alignment. Tax relief does not eliminate operational exposure. In fact, improved margins may bring heightened scrutiny from regulators, lenders and investors. Companies should take the opportunity to evaluate the maturity of their internal controls, financial close processes, revenue recognition practices, inventory safeguards and system-level data integrity. A proactive risk assessment and controls review can help identify weaknesses early, before they surface during an audit or complicate a transaction.
The rule hasn’t changed yet, but your preparation should.
Contact Us
Big decisions are easier when you have the right information and a team you can trust. We combine technical accounting and tax expertise with deep experience in due diligence and structuring. Our goal is simple: to give you the clarity and confidence you need to make the moves that will transform your business.
To discuss our cannabis advisory services or learn more about this topic, please contact your PKF O’Connor Davies client service team or reach out directly to one of our specialists:
Michael Blum, CPA
Director
mblum@pkfod.com | 631.397.0379
Joseph D’Auria, CPA
Partner
jdauria@pkfod.com | 631.926.5654
Lazaro Hernandez, CPA
Partner
lhernandez@pkfod.com | 551.751.9636