Rescheduling Cannabis Could Mean Tax Relief and More to Cannabis Companies

Date November 8, 2023
Categories
Article Authors
Ofek Peer

In recent years, the landscape regarding the legal production, sale, and use of cannabis in the U.S. has been in constant development. One significant change that has been proposed and debated is rescheduling Tetrahydrocannabinols (THC) including Delta-8 THC, Delta-9 THC, dronabinol and others (hereinafter referred to as cannabis) from its current status as a Schedule I controlled substance to a Schedule III controlled substance. Such a move should have wide-reaching implications, including dramatic changes in cannabis companies’ income tax reporting and obligations.

In the U.S., controlled substances are classified into different “schedules” under the Controlled Substances Act (CSA). The scheduling system, overseen by the Drug Enforcement Administration (DEA), categorizes substances based on their potential for abuse and accepted medical use. Schedule I substances are considered the most dangerous, with a high potential for abuse and no recognized medical value, while Schedule V substances are considered the least dangerous. Currently, cannabis is classified as a Schedule I substance, which has significant implications for both its legal status and how it is taxed.

As a Schedule I substance, cannabis is subject to particularly burdensome federal taxation through a provision known as Section 280E of the Internal Revenue Code. Section 280E disallows businesses trafficking in CSA Schedule I and II controlled substances from deducting ordinary business expenses when calculating their federal income tax. This results in effective tax rates for cannabis businesses that can exceed 70 percent, making it highly challenging for legal cannabis businesses to compete and thrive.

On August 29, 2023, The Department of Health and Human Services sent a letter to the DEA requesting a rescheduling of cannabis to a Schedule III controlled substance. Rescheduling cannabis would ultimately signify that the government acknowledges its potential for medical use. The change in status could also have several significant tax-related effects:

  • Tax deductions: Under Schedule III, cannabis businesses can deduct a broader range of their business expenses when calculating federal income tax leading to lower tax burdens for cannabis companies, making it easier for them to operate profitably.
  • Improved industry viability: Lower tax liabilities may attract more entrepreneurs and investors to the cannabis industry, thereby promoting its growth. This growth could create jobs, generate tax revenue for local, state, and federal governments, and reduce the influence of the illicit market.
  • Increased research and development: Rescheduling could encourage more research and development in the cannabis industry, leading to innovations in both medical and recreational products. Such innovations could further expand the industry’s economic potential.

    • It is unclear, but unlikely, the Internal Revenue Service will allow amending previous years’ tax returns to exclude the limitations under section 280E.

    Rescheduling cannabis is a complex issue with many considerations beyond taxation. It would require legislative action, and there is no guarantee of its success. The process would also involve extensive research to determine the appropriate scheduling and regulatory framework. Additionally, some stakeholders may express their concerns about potential consequences of rescheduling, such as its impact on public health and safety.

    If you have questions, please contact the HBK Cannabis Solutions.

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