Deschedule Cannabis, Don’t Reschedule It: Part 2

Last week, I wrote a piece entitled “Deschedule Cannabis, Don’t Reschedule It.” The post came on the heels of President Joe Biden’s announcement that the federal government is considering the federal scheduling of cannabis. As I noted, rescheduling cannabis to schedule II or below is a bad idea, because it would subject cannabis to DEA regulations similar to prescription drugs. I want to devote this post to exploring the serious tax implications on cannabis businesses if the federal government rescheduled cannabis on schedule II specifically.

Anyone familiar with the cannabis industry has heard of section 280E of the Internal Revenue Code, a topic we’ve written about often over the years. Section 280E provides in full:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

In other words, businesses that “traffic” in substances on schedules I or II of the Controlled Substances Act cannot make federal tax deductions (with some limited COGS exceptions which are outside the scope of this post). This means that any state-licensed cannabis business currently is subject to much higher taxes than it would be if it sold other consumer goods, by virtue of the fact that it can’t take standard deductions. If a business were to sell drugs that were currently on schedule II without the proper entitlements, it would also be subject to 280E.

Now let’s take a step back and look at the rescheduling issues. If the Drug Enforcement Administration rescheduled cannabis to schedule II, it would create a pathway for cannabis to be prescribed (as opposed to current physician recommendations) by certain licensed healthcare professionals, in accordance with DEA regulations. Rescheduling cannabis to schedule II would NOT have the effect of making all state-licensed cannabis businesses federally legal. They would still be federally illegal, and as mentioned, a new channel for federally legal physician prescriptions would open up.

In other words, if DEA reschedules cannabis, all state-licensed cannabis businesses would still violate federal law; but instead of trafficking in a schedule I narcotic, would traffic in a schedule II narcotic. This would mean that section 28oE would still govern and cannabis businesses would get little relief. Add to that the fact that a massive sea change in federal law and policy would take place overnight (increasing the cost of compliance and uncertainty), moving cannabis to schedule II is not a good idea.

If President Biden is determined to reschedule cannabis, it would be best on schedule III or below, where 280E would not apply. That said, as I argued in my last post, rescheduling cannabis would create more issues than simply descheduling cannabis.