The year 2024 could be witness to a major regulatory change for cannabis. Federally, the push for cannabis to be rescheduled from a Schedule I drug to a Schedule III drug will continue its forward momentum.
An August 2023 letter from the U.S. Department of Health and Human Services (HHS) contains a recommendation to reschedule cannabis to Schedule III, a classification designating a drug has a medical use but requires a prescription. With its recommendation, then, the HHS is indicating that cannabis has an accepted medical use, among other things that support rescheduling. The recommendation has the potential to begin a shift in the national perception of the cannabis industry as well as allow cannabis-oriented businesses access to benefits not previously available to those businesses.
The HHS recommendation is just the start of this journey; there are multiple roadblocks to advancing their decision, including that the Drug Enforcement Administration (DEA) would have to agree with the recommendation. The decision would also be subject to the Administrative Procedures Act, which would give the public and the court system the opportunity to weigh in on rescheduling. Additionally, the Food and Drug Administration (FDA) would likely provide guidelines or subject cannabis to existing regulatory authority. As such, the rescheduling process could continue into 2025. Still, slow progress is forward progress for our budding industry.
What would this rescheduling mean for canna-businesses?
Cannabis currently is classified as a Schedule I drug, a classification for drugs that have the most potential for abuse and no acceptable medical uses. As such, the cultivation, distribution, and use of cannabis is illegal under federal law and subject to Section 280E of the Internal Revenue Code (IRC) which prohibits the deduction for tax purposes of otherwise normal expenses that businesses in other industries are allowed to take. Rescheduling to Schedule III would imply a lower level of federal restriction, which could have several positive implications for canna-businesses:
Access to tax deductions and a reduced tax burden
Probably most significantly, IRC Section 280E would no longer apply. As in other industries, normal business expenses would be deductible on canna-businesses’ federal tax returns. The inability to take advantage of these deductions has prevented businesses, from small retail stores to large multi-state operators, from maximizing their profitability due to a large tax liability. With access to a broader range of deductions, canna-businesses would be looking at a substantial reduction in their overall tax burden, from hundreds to millions of dollars. Absent legislative or judicial relief, taxes paid in prior years with IRC Section 280E in effect are unlikely to be refunded and unpaid taxes from those years are still likely to be owed. With rescheduling potentially on the horizon, businesses need to keep abreast of changes in tax regulations to optimize their deductions as well as maintain compliance with any new regulations.
Potential for growth and investment
Rescheduling to Schedule III would likely attract more outside investors to the cannabis industry as they could expect reduced risk due to federal illegality for canna-businesses. Increased outside investment could help fuel business expansion as well as research and development and infrastructure improvements. Rescheduling could cause the market exchanges, including Nasdaq and the NYSE, to re-evaluate their position on companies to be listed on their exchanges, which would allow for more visibility for companies in the industry currently ineligible for listing. To capitalize on the wider-reaching potential for growth, businesses would need to make both in-house and in-market adjustments. Given the potential for a larger consumer base, which will inevitably shape consumer trends, businesses must prepare to alter their financial strategies. With the federal rescheduling of cannabis, business could expect new investors and/or diversified partnerships, not only for canna-businesses but across a variety of industries. Considering these opportunities, businesses would need to maintain awareness of the evolving investment landscape in order to optimize their potential in this changing market.
Access to banking services
Many cannabis businesses currently face challenges when it comes to accessing traditional banking services due to the imposed federal restrictions. As it stands, there is significant gray area in banking operations due to the disparity between states where marijuana is legal and the current federal status as a Schedule I drug. Rescheduling to Schedule III could lead to improved access to banking services, allowing businesses to manage finances more efficiently and fairly. It could also lead to widespread access to merchant services to help process transactions; currently, even though most operators have a depository relationship, they are still collecting a tremendous amount of cash as most major service providers will not work with canna-businesses.
Moving away from a historically cash-heavy system would enhance both financial security and transparency among the businesses, thus lowering, or removing, the current legal, operational, and regulatory risks for both bank and business. Given this potential shift, businesses would need to prepare for federal regulation that would clear the smoke between the industry and banking access.
Impact at the state level
Rescheduling could push the government to be proactive and establish a regulatory framework for interstate commerce, which could lead to businesses running more efficiently and using their capital in a more beneficial way as there would no longer be a need for duplicate facilities from state to state. It would also allow businesses with a specialized product to reach across state lines into larger markets. On the flip side, if the proper framework is not put into place, products from other states could over-saturate a market in an already difficult business climate. States will also want to protect their own cannabis industries, so they would likely impose import and export tariffs as well as interstate commerce taxes.
Rescheduling would result in a newly evolving framework of legal and financial practices, which will provide both challenges and opportunities for cannabis businesses. Navigating this framework will require advisement to ensure compliance at both state and federal levels. By navigating this framework, businesses could optimize their potential while minimizing risk and avoiding legal and financial complications, thus anticipating long-term success.
With the possibility of rescheduling on the horizon, it is all but certain that state regulators will reevaluate existing policies and procedures, the federal government will increase oversight and compliance requirements, and the way cannabis business operate will undergo a seismic shift. In this ever-changing world of cannabis, the experts at HBK Cannabis Solutions, who have been helping cultivators, manufactures, and retailers navigate the evolving landscape of tax, finance, financial reporting, and business management tools for nearly a decade, are here to support your canna-business. We look forward to the opportunity to answer any questions and continue the dialogue on this exciting industry.
For more information, contact HBK Cannabis Solutions at Matt Gannon at mgannon@hbkcpa.com.
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