On December 18, 2025, President Trump issued an executive order, “Increasing Medical Marijuana and Cannabidiol Research” directing the U.S. Attorney General to reclassify cannabis from a Schedule I controlled substance to a Schedule III controlled substance under the Controlled Substances Act. The Executive Order notes that cannabis’ current classification has impeded medical marijuana and CBD research and it is “critical to close the gap between current medical marijuana and CBD use and medical knowledge of risks and benefits.”
As a Schedule I controlled substance, cannabis businesses were unable to deduct ordinary and necessary expenses paid in carrying on their trade or business for federal tax purposes under Section 280E of the Internal Revenue Code (“Section 280E”). Section 280E disallowed deductions for business expenses if such trade or business consisted of “trafficking in controlled substances” as defined in Schedule I and II of the Controlled Substances Act. This means that cannabis businesses cannot deduct typical operating expenses such as rent, utilities, employee wages, advertising, or legal fees. Cannabis businesses can still subtract the cost of goods sold (COGS) from their gross receipts to determine gross income. COGS includes direct costs related to the production or acquisition of the product itself, such as raw materials, packaging, and labor directly involved in cultivation or manufacturing. This allowance provides some relief for cultivators and manufacturers, but Section 280E imposes crushing tax burdens on retailers, with many paying an effective tax rate of 60-70% or more. Section 280E coupled with state-regulated licensing and testing requirements make running a cannabis business exceptionally expensive, and virtually untenable for most small retailers. Because the Executive Order removes cannabis from the definition of businesses engaged in “trafficking” under Section 280E, cannabis businesses will be able to deduct their business expenses for federal tax purposes if and when rescheduling occurs.
However, the Executive Order does not accomplish rescheduling in and of itself. Rather, it tasks the U.S. Attorney General with rescheduling cannabis “in the most expeditious manner in accordance with Federal law.” The rulemaking process requires that the rule must go through public comment period and then the final rule must be published in the Federal Register, which may take several months. It is likely that the Executive Order will be challenged in court as well. Until it is officially reclassified, cannabis is still classified as a Schedule I controlled substance and subject to Section 280E of the Internal Revenue Code. Therefore, cannabis businesses should not take any deductions for business expenses for federal tax purposes until the reclassification is final. The Executive Order provides no indication when the reclassification will take effect. Therefore, businesses should assume that the reclassification of cannabis will apply to tax years starting in the year which the final rule takes effect unless other guidance is provided. If rescheduling occurs in 2026, it is unclear whether cannabis operators will be permitted to claim ordinary business deductions for part or all of 2026. Cannabis businesses should expect to file their 2025 tax returns under the current application of Section 280E, but should speak with their tax advisers about options including evaluating their financials and liabilities for future years and whether there are any corporate restructuring opportunities available given this reclassification.
The impact for state tax purposes will depend on the jurisdiction, as state tax conformity with federal law varies. Certain states, including Connecticut, New York and Massachusetts already decoupled from the federal prohibition of deducting such expenses. Other states automatically follow federal tax law, and some states may impose state specific Section 280E prohibitions after the federal law is finalized. Businesses must continue to comply with both federal and state law after the rescheduling is finalized.
In sum, rescheduling may bring widespread tax relief for cannabis businesses, but there are still several regulatory hurdles to clear before that day arrives.