Quick Answer: California cannabis retailers holding combined A/M licenses are facing a real tax gap in 2026. DOJ’s rescheduling order moved qualifying medical cannabis activity to Schedule III, removing Section 280E for that side of the business, while adult-use activity stays on Schedule I and fully subject to 280E. Treasury has said apportionment guidance for splitting shared expenses between the two is coming, but as of this writing it has not been published. Until it is, 420 Accounting Services builds dual-designation clients a defensible allocation methodology anchored to measurable metrics, applied consistently, and documented as it happens, not reconstructed at tax time, so a 2026 return holds up whenever formal guidance arrives.
How Can California A/M Operators Allocate Expenses While IRS Writes Rules?
Every dual-designated cannabis retailer and retail-authorized microbusiness we talk to this summer is asking some version of the same question: how do I split my expenses between medical and adult-use? Not in theory, but on the actual return we have to file. The honest answer is that there is no published safe harbor yet, and anyone telling you they have the definitive formula is getting ahead of where Treasury actually is.
So, does that mean you wait while the IRS writes the rules? No, on the contrary, it means you must build a defensible position now, using the tools the IRS already trusts. Whenever formal apportionment guidance is published, your 2026 return is already on real documentation instead of a year-end guess.
Understanding What’s Changed for California Cannabis Operators
DOJ’s final rescheduling order moved marijuana covered by qualifying state-issued medical marijuana licenses to Schedule III, while adult-use marijuana generally remains Schedule I. The Department of Cannabis Control moved fast on the state side too, allowing licensees to change A/M designation outside the normal renewal window and giving combined A/M retail licenses a path to split into two separate licenses at the same premises.
When you put those two changes together, you get the situation nearly every California dual-designation retailer and retail-authorized microbusiness is now living in: one business, two federal tax treatments, running through shared staff, shared square footage, and often a shared point-of-sale system. Treasury has said publicly that guidance is coming on how businesses with both covered and non-covered activity should apportion expenses. It has not said what that guidance will require. Read more on the DCC’s emergency rule for split A/M licenses if you have not already restructured. Operators are being asked to file 2026 returns in the gap between “280E no longer applies to some of what you do” and “here is exactly how you prove which part.”
Direct, Indirect, and Shared Costs Across a Bifurcated Schedule
Start by sorting your expenses into three buckets, the same discipline we use for COGS allocation under 280E generally.
| Cost Type | Treatment Approach |
| Direct M-side costs | Trace directly to the medical activity |
| Direct A-side costs | Trace directly to the adult-use activity; remains subject to 280E |
| Shared costs (rent, budtender wages, POS, utilities, management salaries) | Requires a documented allocation methodology |
While the direct costs are the easy part, the shared bucket is where the real work is. It is also where most dual-license retailers and retail-authorized microbusinesses are exposed, because a single point-of-sale system serving both M and A customers under one roof does not sort itself.
How to Create A Defensible Methodology for Your Cannabis Accounting
In the absence of a published safe harbor, the standard the IRS actually applies is not “did you pick the right number.” It is “can you show your work, and is your work consistent with how the business actually operates?”
Below are a few principles we are building into client structures today.
Anchor the Allocation to Something Measurable
Potential allocation metrics may include revenue mix, dedicated square footage, transaction counts, employee time, or other operational measures reasonably related to the expense being allocated. Until Treasury and IRS issue guidance, no particular method should be described as an approved safe harbor. Keep in mind, though, that this is provided the metric is tracked in the ordinary course of business and not reverse-engineered from a target tax outcome.
Match the Allocation to the License Split, Where One Exists
If you have taken advantage of the DCC’s emergency rule and split a combined license into separate A and M entities on the same premises, your general ledger and payroll allocations must mirror that structure from day one. Separate books and records will be particularly important in supporting the allocation, especially where the operator has separated its A and M activities into distinct licenses or entities.
Apply It Consistently, Month Over Month
A methodology that changes every quarter based on which allocation produces a better result is a red flag, and a situation you must avoid.
Document the Reasoning, Not Just the Number
Write down why you chose square footage over revenue mix, or why management payroll splits 60/40 instead of 50/50. That memo is worth more on audit than the spreadsheet itself.
The Labor Allocation Parallel
We have written previously about how the IRS treats payroll as a tax substantiation document in a 280E context, not just an HR record, because labor allocation between COGS and non-COGS activity determines how much of your payroll is deductible. Dual-designation expense allocation is the same problem wearing a different hat.
A percentage allocation is considerably more defensible when supported by contemporaneous records demonstrating how the percentage was determined and consistently applied. An operator who tells an examiner “60% of shared overhead is medical” because a spreadsheet built when it is time to file taxes in April 2027 says so is in the same position as the cultivator we described in our payroll piece, who lost part of a labor allocation not because the number was wrong, but because nothing beyond a year-end file supported it. The lesson transfers directly: allocation built after the fact, specifically to support a tax position, invites exactly the scrutiny it was meant to avoid.
What to Capture Now, Before You Need It
You do not need to wait for Treasury to start building the record that will support your 2026 return. Start capturing this today:
- Revenue and transaction data segmented by A and M designation, pulled directly from your POS system
- Square footage allocation by license, especially if you operate a split A/M premises under the DCC emergency rule
- A written allocation policy stating your methodology and the reasoning behind it, dated and version-controlled
- Payroll and time records for staff who work across both designations, coded consistently with your allocation methodology
- Monthly reconciliation of shared costs against your chosen allocation metric
- A file of every DCC designation change, license split filing, and entity restructuring document tied to the timing of your allocation changes
None of this requires guessing at what Treasury will eventually say. It requires treating your 2026 books the way you would want them to look if an examiner opened them in 2028.
420 Accounting Services works exclusively with cannabis businesses, and dual-designation allocation is one of the most common structural questions we are building into client accounting systems right now. If your entity holds both M and A designations and you want a second set of eyes on your allocation methodology before you file, contact us to schedule a free consultation or explore our cannabis accounting and compliance services to learn how we can help.
FAQ: Dual A/M License Expense Allocation
1) Does 280E still apply to my dispensary?
It depends on which side of your business you mean. If your medical activity falls within the Final Order, Section 280E generally should no longer bar deductions attributable to that qualifying activity, subject to forthcoming Treasury and IRS guidance. Your adult-use (A) activity remains Schedule I and fully subject to 280E. If your medical activity falls within the Final Order, Section 280E generally should no longer bar deductions attributable to that qualifying activity, subject to forthcoming Treasury and IRS guidance.
2) Is there an official formula for splitting expenses between M and A?
Not yet. Treasury has indicated that apportionment guidance is coming for businesses with both covered and non-covered activity, but as of this writing, it has not been published. Operators need a documented, defensible methodology in the meantime.
3) Does splitting my combined license into separate A and M licenses help?
It can, but only if your books, payroll, and operations actually reflect that separation. A license split on paper without matching accounting segregation is unlikely to hold up.
4) What records should I start keeping now?
Revenue and transaction data by designation, square footage allocation, a written and dated allocation policy, payroll records coded to match your methodology, and monthly reconciliations. Build these into your ordinary bookkeeping process rather than reconstructing them at tax time.
Frequently asked questions this article answers: Does 280E still apply to my dispensary? Is there an official formula for splitting expenses between M and A? Does splitting my combined license into separate A and M licenses help my tax position? What records should California dual-designation retailers and retail-authorized microbusinesses start keeping now? How should shared costs like rent and budtender wages be allocated between medical and adult-use activity? What does a defensible expense allocation methodology look like before the IRS issues guidance?