Does 280E Still Apply in 2026?
For a Colorado marijuana licensee filing a federal return today, the working assumption should be that Internal Revenue Code Section 280E still applies. 280E denies deductions and credits for a trade or business trafficking in a controlled substance listed in Schedule I or Schedule II of the federal Controlled Substances Act. Its application to state-licensed marijuana businesses has always turned on marijuana's federal schedule — not on state legality, license type, or whether a customer holds a Colorado medical registry card.
That is also why the rescheduling discussion matters. If marijuana were moved to Schedule III, the statutory hook that 280E depends on would no longer describe marijuana by its plain terms. But moving from that observation to a specific number on a specific return is not automatic, and it is exactly where operators are most likely to get into trouble. Effective dates, tax-year mechanics, treatment of prior periods, whether a change applies to all cannabis activity or only certain activity, and how shared costs are allocated in a mixed operation are the sorts of questions Treasury and the IRS would ordinarily need to address through guidance. As of this writing those questions are unresolved.
So the honest answer has four parts. Established: 280E is current law and continues to apply to businesses trafficking in Schedule I or II substances, and cost of goods sold remains a reduction of gross receipts rather than a deduction. Changing: the federal scheduling posture for marijuana has been the subject of an active administrative process, and the outcome would directly affect 280E's reach. Unresolved: the timing, scope, and administrative mechanics of any change, including how the IRS would expect taxpayers to treat transition years. Practical: a Colorado operator does not have to predict any of this to prepare for it, because every plausible outcome rewards the same thing — accounting records that can substantiate revenue, inventory, cost of goods sold, and the allocation of shared expenses.
Nothing in this guide is a prediction that 280E has gone away, and no Colorado licensee should file as if it has based on news coverage. What follows is how to think about the distinctions that would matter, and what to build now. If you want that translated into your own numbers, our Section 280E tax planning service is where that work happens.
- 280E remains current law and continues to govern federal returns for businesses trafficking in Schedule I or II substances.
- Rescheduling to Schedule III would remove the plain statutory hook, but effective dates and administrative mechanics would still need to be addressed.
- Colorado's state-level subtraction for federally disallowed 280E expenditures is a separate calculation and is unaffected by federal speculation.
- Do not take a filing position based on anticipated guidance that has not been issued.
Medical vs. Adult-Use Cannabis: Why the Difference Matters for 280E
Colorado has run parallel regulated markets for more than a decade. The Marijuana Enforcement Division licenses medical marijuana businesses — Medical Marijuana Stores, cultivations, and infused products manufacturers serving patients on the state registry — alongside retail (adult-use) businesses serving any purchaser twenty-one or older. Many Colorado operators hold both license types, frequently at the same or adjacent premises, with separate inventory tracked in METRC and separate tax treatment at the state level.
Under current federal law that distinction has not mattered for 280E. Medical and adult-use marijuana are the same substance federally, and 280E has been applied to medical operators and adult-use operators alike. Colorado medical operators have never been able to deduct ordinary operating expenses federally simply because their customers are registered patients.
Why raise the distinction at all, then? Because a change in federal scheduling would not necessarily land on both markets identically, and the accounting consequences of any asymmetric treatment would fall hardest on operators who cannot separate the two streams in their books. If federal treatment ever diverged by activity type — and whether it would is unresolved — an operator's ability to claim different treatment would depend entirely on whether its records could prove which revenue, which inventory, which labor hours, and which share of rent belonged to which activity. Operators whose general ledger shows one undifferentiated 'sales' account and one undifferentiated 'rent' expense would have no factual basis to allocate anything.
This is the practical asymmetry worth internalizing: separating medical and adult-use activity in your accounting costs relatively little and is useful for management reporting regardless. Failing to separate it costs nothing today and could cost a great deal in a year where the distinction suddenly carries federal tax weight. Colorado's existing regulatory structure already forces much of the separation — separate licenses, separate METRC inventory, different state tax treatment — so the accounting work is largely a matter of carrying that separation through into the general ledger.
- Colorado licenses medical and retail marijuana businesses separately, and many operators hold both.
- Under current federal law, 280E applies to medical and adult-use activity alike.
- Colorado state tax already treats the two differently — 15% retail marijuana sales tax on adult-use versus 2.9% state sales tax plus local rates on medical.
- Records that cannot distinguish the two leave an operator unable to support differentiated treatment if federal law ever draws that line.
The Mixed-Use Cannabis Accounting Problem
Consider a Colorado operator we will call a dual-licensed Denver retailer: one building, a medical store and a retail store operating under separate MED licenses, shared back-of-house storage, one security contract, one landlord, one payroll system, and staff who work both counters depending on the day. Roughly a third of revenue is medical. The books have a single rent expense, a single wages account, one utilities account, and revenue split only because the point-of-sale system happens to report medical and retail separately for state tax filing.
That operator can tell you total revenue by market because Colorado's sales and excise tax filings require it. It cannot tell you gross margin by market, labor cost by market, or what share of the building's rent supports medical activity — because nothing in the accounting system was designed to answer those questions. Under today's rules that gap is a management reporting weakness. In a world where federal treatment differed by activity, the same gap would be a substantiation failure.
The mixed-use problem breaks into two categories of cost. Direct costs are traceable to one activity by their nature: product purchased into medical inventory, packaging consumed on medical orders, a budtender who works only the medical counter. These are the easy ones, and the fix is coding discipline at the point of entry rather than reconstruction at year end. Indirect and shared costs — rent on common space, security covering the whole premises, the utility bill, accounting software, insurance, management salaries, professional fees — serve both activities simultaneously and cannot be traced. These require an allocation, and an allocation is only as good as the records and reasoning behind it.
There is no IRS-blessed formula for splitting shared cannabis expenses between medical and adult-use activity, and this guide is not going to invent one. What is defensible in principle is a method that is documented in advance, tied to a measurable driver that genuinely relates to how the cost is consumed, applied consistently across periods, and supported by contemporaneous records rather than reconstructed later. Square footage for occupancy costs, actual hours worked for labor, transaction counts or units moved for consumption-driven costs — these are the kinds of drivers that businesses in every industry use to allocate overhead, and the reasoning behind the choice matters as much as the choice itself.
What the accounting system has to support, at minimum, is revenue segmentation between medical and adult-use; inventory tracked so that cost attaches to the right stream; direct expenses coded to the activity that incurred them; shared expenses collected in identifiable pools with a documented allocation basis; payroll captured with enough detail to reflect what people actually did; and reconciliations tying point-of-sale reports and METRC movement back to the ledger. Our cannabis bookkeeping service and dispensary accounting service are built around exactly that structure for Colorado retailers.
- Direct costs should be coded to a market at entry, not reconstructed at year end.
- Shared costs need identifiable pools and a documented, driver-based allocation basis.
- Payroll needs enough granularity to reflect actual activity where staff work across both markets.
- POS, METRC and the general ledger must reconcile, by market where the data supports it.
- No IRS-approved medical/adult-use allocation methodology exists; consistency and documentation carry the weight.
Cannabis 280E Expense Allocation and Apportionment
Allocation is not a new problem for cannabis accounting. Under current law, Colorado operators already run an allocation exercise every year: which costs are properly inventoriable and therefore recovered through cost of goods sold, and which are operating expenses disallowed under 280E. Every vertically integrated licensee already splits payroll between production and non-production labor, and every cultivation facility already allocates facility costs between grow space and administrative space. The apportionment discussion that Schedule III raises is a second axis laid over the same records — not a new discipline.
The shared costs that matter most in a Colorado mixed operation are predictable. Rent and occupancy, where one lease covers medical retail, adult-use retail, and shared storage. Payroll and management compensation, where the same general manager oversees both operations. Security, which is a MED requirement and typically covers the whole premises under one contract. Utilities, which are metered for the building rather than by activity. Software — POS, seed-to-sale integration, accounting, scheduling — usually licensed at the entity level. Insurance. Professional services, including legal, accounting and compliance consulting. Shared equipment and shared vehicles.
For each of these, the questions an auditor would ask are the same: what is the pool, what drives it, why is that driver appropriate, is the method applied consistently, and what contemporaneous record supports the numbers used? An allocation supported by a signed lease with a square-footage schedule, a floor plan, and a consistent monthly journal entry is a different artifact from a spreadsheet built in March showing a round 70/30 split with no underlying measurement.
Two cautions. First, an allocation method is not a deduction. Documenting how you split rent does not establish that any portion of it is deductible under federal law — that depends on the statute and any guidance as it exists at the time of filing. Second, do not build a method to reach a target. A method chosen because it produces a favorable answer, then reverse-engineered into a rationale, is precisely what an examiner is trained to identify. Pick the driver that describes how the cost is actually consumed, and let the number fall where it falls.
- Occupancy costs commonly allocate on measured square footage supported by a floor plan and lease schedule.
- Labor allocates most defensibly on actual recorded hours or documented role assignments, not estimates.
- Consumption-driven costs may allocate on transaction counts, units, or another measurable driver.
- Write the policy down before the period, apply it consistently, and revisit it only for documented operational reasons.
- Documenting an allocation does not make an expense deductible — it makes the accounting defensible.
Chart of Accounts After Schedule III
The chart of accounts is where all of this becomes real. Most Colorado operators can accommodate medical/adult-use separation without a rebuild, using the dimensional tools their accounting system already provides — classes, departments, locations, or tracking categories depending on the platform — layered over a chart of accounts that stays stable across periods.
The design goal is to be able to produce, for any period, a revenue and gross margin picture by market; a labor cost picture by market; a schedule of directly attributable operating expenses by market; and a schedule of shared cost pools with the allocation applied and the basis stated. If the system can produce those four outputs without a manual reconstruction project, it will accommodate most plausible federal outcomes.
A few structural points are worth attention. Keep inventory and cost of goods sold accounts capable of distinguishing medical and adult-use product, which for most Colorado retailers follows naturally from METRC's separate inventory tracking. Keep payroll accounts split at least between production and non-production labor, and add market-level detail where staff are genuinely dedicated. Hold shared costs in clearly labeled pool accounts rather than pre-splitting them at entry, so the allocation is a visible, documented step rather than an invisible assumption. Use location dimensions for multi-premises operators. And keep the mapping between the accounting system, the point-of-sale reports, and METRC documented, because the reconciliations depend on it.
Avoid the temptation to create speculative accounts for tax positions that do not exist yet. A clean, dimensioned chart of accounts adapts. A chart of accounts full of accounts named after a hypothetical future rule becomes a mess that has to be cleaned up either way. Our cannabis financial reporting service covers the reporting side of this structure for Colorado operators.
- Use classes, departments or locations for market segmentation rather than duplicating the account list.
- Keep inventory and COGS capable of distinguishing medical from adult-use product.
- Hold shared costs in labeled pool accounts so allocation stays a visible, documented step.
- Document the mapping between the ledger, POS reports and METRC.
- Do not create accounts for tax positions that do not currently exist.
Inventory and COGS Still Matter
Under 280E, cost of goods sold is the only meaningful path to recovering cost, which is why cannabis inventory accounting receives the scrutiny it does. It would be a mistake to conclude that a change in scheduling makes inventory accounting less important. If anything, the opposite is true. Inventory costing determines the timing of cost recovery under any tax regime, drives gross margin, underpins the financial statements a lender or investor relies on, and is the account most likely to be examined because it is the one most dependent on judgment.
For a Colorado licensee, the substance of that work is unchanged: identify which costs are properly capitalized into inventory under the applicable rules, apply a consistent costing method, track product through METRC and reconcile that movement to the ledger in dollars, count physical inventory on a defined cycle, and investigate and document variances rather than plugging them. A cultivator capitalizing grow labor, nutrients, and allocable facility cost into harvested product is doing the same accounting whether or not 280E applies to the resulting operating expenses.
In a mixed operation, inventory work carries the additional requirement of keeping medical and adult-use product costed separately through the whole chain, which Colorado's separate METRC tracking largely supports. Where a vertically integrated operator transfers product from its own cultivation into both a medical and a retail store, the transfer pricing and cost attachment need to be consistent and documented — an area where informal practice is common and defensible documentation is not.
Our inventory and cost accounting service and METRC reconciliation service cover this ground, and the cannabis inventory accounting guide walks through 471 and 263A costing in more depth.
- COGS remains the primary cost-recovery mechanism under current law and remains central to margin and reporting under any regime.
- Costing methodology should be written down, applied consistently, and reviewed at least annually.
- METRC movement must reconcile to ledger inventory in dollars, not just in units.
- Internal transfers between cultivation and retail need consistent, documented cost attachment.
Documentation and Audit Defense
A period of federal change tends to increase examination attention rather than reduce it. Transition years produce inconsistent filing positions across an industry, and inconsistency is what draws review. The Colorado operators best positioned for that environment are the ones whose records were already assembled contemporaneously, because reconstruction after the fact is both expensive and visibly weaker.
The evidentiary package for a cannabis operator is well understood. Point-of-sale reports supporting recorded revenue, discounts, comps and returns, retained at a level of detail that permits medical and adult-use separation. Seed-to-sale records from METRC showing package-level movement, transfers, and destruction, reconciled to the books. Payroll records with hours and role or department detail. Vendor invoices and purchase records supporting inventory. Physical inventory counts with variance investigation notes. Allocation workpapers showing the pool, the driver, the measurement, and the computation. A written accounting policy memo describing costing and allocation methodology and the date it was adopted. Bank, merchant and cash reconciliations. And supporting schedules tying the general ledger to the return.
Two habits do most of the work. First, produce the workpapers in the period they describe — a monthly allocation entry supported by a monthly schedule is worth far more than an annual estimate. Second, write down the reasoning, not just the numbers. An examiner encountering a policy memo that explains why square footage was chosen for occupancy costs is evaluating a considered method; an examiner encountering only a percentage is evaluating a guess.
Where a Colorado operator is already under examination or expects to be, our cannabis tax audit defense service and the audit preparation guide cover how those engagements actually run.
- Retain POS detail at a level that permits medical/adult-use separation.
- Reconcile METRC to the ledger monthly and keep the reconciliation as a workpaper.
- Keep allocation workpapers showing pool, driver, measurement and computation for each period.
- Maintain a dated written accounting policy memo covering costing and allocation methodology.
- Contemporaneous records are materially stronger than reconstructions built during an examination.
What Colorado Cannabis Businesses Should Do Now
Nothing here requires a Colorado operator to take a position on unresolved federal questions. Every step below is defensible under current law, useful for management, and positions the business to implement future guidance quickly if and when it arrives.
Start with the books themselves. Close monthly on a real calendar, reconcile bank, merchant and cash accounts, and stop carrying unexplained balances. A business that cannot close a month cannot substantiate a year. From there, add market segmentation: make sure revenue, inventory, COGS and directly attributable expenses can be reported separately for medical and adult-use activity, using the dimensional tools already in your accounting system.
Then address shared costs deliberately. Identify every material shared expense, group it into a pool, choose a driver that reflects how the cost is consumed, measure that driver — square footage from an actual floor plan, hours from actual timekeeping — and write the policy down with the date it was adopted. Apply it monthly. Where staff work across both markets, upgrade timekeeping so hours reflect activity rather than a single blended code; this is usually the single highest-value change a dual-licensed Colorado retailer can make.
Keep inventory defensible. Maintain the costing methodology in writing, run physical counts on a defined cycle, reconcile METRC to the ledger monthly, and investigate variances in writing. Preserve source documentation — invoices, POS exports, payroll registers, METRC reports — in an organized structure rather than scattered across email and drives, and keep it for the full statute period.
Finally, keep the Colorado layer straight. State income tax allows a subtraction for expenditures disallowed federally under 280E, and that subtraction requires a detailed schedule reconciling to the federal return. State and local sales and excise tax obligations differ between medical and adult-use sales — 15% retail marijuana sales tax on adult-use, 2.9% state sales tax plus local rates on medical — and those filings are unaffected by federal scheduling. The Colorado cannabis tax guide covers those mechanics, and our sales tax compliance service handles the filing side.
One thing not to do: do not change a filing position, restructure an entity, or defer a tax payment on the expectation of a federal change that has not been finalized in guidance you can cite. Prepare the accounting; wait for the rule.
- Close monthly and reconcile bank, merchant, cash and inventory accounts on a real schedule.
- Segment medical and adult-use revenue, inventory, COGS and direct expenses in the ledger.
- Adopt a written, dated allocation policy for shared costs and apply it monthly.
- Upgrade timekeeping so shared labor is recorded by actual activity.
- Keep the Colorado 280E subtraction schedule and state/local tax filings current regardless of federal developments.
- Do not take filing positions based on guidance that has not been issued.
Questions Colorado Cannabis Operators Should Ask Their CPA
A short list of direct questions will tell you quickly whether your accounting is positioned for a changing federal environment. If the answers are vague, that is the finding.
- Does 280E currently apply to all of our activity, and how is that reflected on our most recent return?
- Can our accounting system distinguish medical from adult-use revenue, inventory and cost of goods sold today?
- How are shared expenses — rent, security, utilities, software, management — currently tracked and allocated, and is that method written down?
- Is payroll tracked by actual activity where staff work across both markets, or coded to a single blended account?
- Can our inventory balances and COGS be substantiated with counts, costing workpapers and source documents?
- Do our POS reports, METRC records and general ledger reconcile, and how often is that reconciliation performed?
- What contemporaneous documentation supports our current cost accounting and allocation treatment?
- Are we computing and supporting the Colorado state subtraction for federally disallowed 280E expenditures?
- What specific accounting changes would we need to make if federal guidance altered 280E's application, and how quickly could we make them?
Talk Through Your 280E Position With a Colorado Cannabis CPA
This guide is informational. Applying it to a particular Colorado license portfolio — a dual-licensed store, a vertically integrated operation, a cultivation facility supplying both markets — takes a review of your actual books, your METRC data and your prior returns.
Our Section 280E tax planning engagement covers cost accounting methodology, allocation policy, the Colorado state subtraction and return preparation support. Call (720) 730-6673 or schedule a consultation and we will walk through where your records stand and what would need to change if federal treatment shifts.
