The state-licensed cannabis industry has been operating under significant constraints due to cannabis’s classification as a Schedule I substance under the federal Controlled Substances Act of 1970. This categorization, which groups cannabis with drugs like heroin and LSD, has faced growing criticism as an increasing number of states legalize cannabis for medical and recreational purposes. However, the industry may soon experience a major shift, as the Drug Enforcement Administration (DEA) moves to reschedule cannabis to Schedule III. This decision follows a recommendation from the Department of Health & Human Services (HHS), which is supported by scientific evidence reviewed by the FDA.
It’s important to note that the rescheduling process will take time before it officially takes effect. After the White House reviews the DEA proposal, a proposed rule will be published in the Federal Register. A public-comment period will follow before the proposed rule can become final. The process will almost certainly give rise to litigation and it remains unclear how long the process will take.
Impact on Taxation: Removal from Section 280E
One of the most significant effects of this rescheduling would be the removal of cannabis from the purview of I.R.C. Section 280E. This tax code provision has been a substantial obstacle for state-licensed cannabis businesses, preventing them from deducting many ordinary business expenses when calculating their taxable income. Under 280E, cannabis companies can only deduct the Cost of Goods Sold, leading to considerably higher tax burdens compared to businesses in other industries. With the rescheduling, state-licensed cannabis businesses would be able to deduct ordinary business expenses, creating a more equitable playing field and enabling them to allocate more of their revenues toward growth and expansion.
Challenges in Banking Access
Access to banking services has been another long-standing challenge for the state-licensed cannabis industry due to the federal prohibition on cannabis. Many banks have avoided working with cannabis businesses, concerned about potential legal and regulatory consequences. While the rescheduling to Schedule III might encourage more risk-tolerant banks to engage with the industry, many will likely remain hesitant as long as cannabis remains federally illegal. To comprehensively address these banking hurdles, federal legislation like the SAFER Banking Act is necessary. This act would provide protections for federally-regulated financial institutions such as banks that serve the cannabis industry in states where it is legal. The rescheduling could potentially increase legislative support for such measures, which would support the cannabis industry’s long-term financial stability and growth.
Limitations on Legal Rights and Remedies
Even with the anticipated rescheduling, state-licensed cannabis businesses will continue to encounter restrictions on their federal legal rights and remedies. Due to the ongoing federal prohibition on cannabis, state-sanctioned businesses in the industry will still face difficulties in establishing and protecting intellectual property rights, such as trademarks. Furthermore, access to bankruptcy courts will likely remain restricted, although some courts have recently demonstrated a willingness to allow cannabis-related businesses that are not directly involved in cannabis operations to utilize bankruptcy proceedings.
Conclusion
The expected rescheduling of cannabis to Schedule III will have notable implications for state-sanctioned cannabis businesses. The removal of cannabis from I.R.C. Section 280E will provide significant tax relief for state-licensed cannabis operators, and the possibility of increased banking access could enhance the industry’s financial stability and growth potential. Nevertheless, cannabis companies will continue to face certain limitations stemming from the persistent federal prohibition of cannabis. As the legal landscape evolves, it is essential for cannabis businesses to remain informed about industry developments and to collaborate with legal professionals who can offer guidance and support in navigating the shifting regulatory environment.
If you have any questions or require assistance, please contact Sean P. Gallagher.
This alert serves as a general summary and does not constitute legal guidance. Please contact us with any specific questions.
Sean P. Gallagher is an attorney at Fraser Trebilcock with experience in the highly regulated cannabis industry, working with local and state officials to advance client interests and to help mitigate risks involved and increase opportunities. You can reach him at 517.377.0820 or at sgallagher@fraserlawfirm.com.
