On October 6, 2022, President Biden pardoned all federal offenses related to marijuana possession. That same day, Biden directed the Secretary of Health and Human Services and the Attorney General to begin the administrative process of reviewing how cannabis is classified under federal law. This action has now led the U.S. Department of Health and Human Services (“HHS”) to recommend in an August 29, 2023 letter to the Drug Enforcement Administration (“DEA”), that cannabis, which is currently a Schedule I drug under the Controlled Substances Act (“Controlled Substances Act”), CSA”), it will be reclassified as a Schedule III drug. The ball is now in the DEA’s court. If the DEA and the Department of Health and Human Services agree, we could be on the cusp of the biggest change in US cannabis policy since 1970.
Schedule I vs. Schedule III: The Big Differences
The CSA consists of five schedules, with substances categorized into a schedule based on whether they have a medical use and potential for abuse. Since 1970, cannabis has been a Schedule I drug, meaning it has no accepted medical use and a high potential for abuse.1 Examples of other Schedule I drugs are heroin, LSD, and MDMA (“ecstasy”). On the other hand, Schedule III drugs have an acceptable medical use and are considered to pose a moderate risk of abuse or addiction. In this context, a moderate potential of abuse means that a substance can lead to low or moderate physical dependence or high psychological dependence. Thus, it can apply to substances that do not possess physical addictive qualities. Doctors frequently prescribe Schedule III drugs and include drugs such as Tylenol with codeine and testosterone.
There are two ways in which matter can be moved to a different timeline under the CSA. The first is by a decision of Congress. The second method is through setting up Department of Justice (“DOJ”) regulations that require, as an initial step, determination that the substance has an acceptable medical use by the Department of Health and Human Services. Many state legislatures have long recognized that cannabis has a medicinal use, but the federal government has not. Although the letter to the DEA was not publicly available, the fact that the Department of Health and Human Services is recommending that cannabis be reclassified as a Schedule III drug means that it is likely the first time the federal government has recognized cannabis as having an acceptable medical use. .2 Thus, the HHS letter marks an important initial step that would enable the DOJ to reschedule cannabis through its own standard rulemaking process, without congressional approval.
Department of Health and Human Services on Aug. 29y The letter does not guarantee that cannabis will be reclassified as a Schedule III drug; Alternatively, the DEA, as part of the Department of Justice, could now begin its own review of cannabis and decide whether it should be rescheduled. If the DEA agrees with the Department of Health and Human Services and seeks to reschedule cannabis, the Department of Justice will begin rule-making procedures, including providing public notice of proposed changes and allowing for a public comment period.
Implications for rescheduling for cannabis operators
If hemp is rescheduled to Schedule III, there could be a number of significant benefits for operators in the US cannabis industry. The most important benefit will be the elimination of the “280E penalty”. Section 280E of the Internal Revenue Code generally does not allow tax deductions for ordinary and necessary business expenses, other than those that are properly treated as cost of goods sold, incurred in connection with commercial trafficking in Schedule I or Schedule II controlled substances. As a result, cannabis operators are generally subject to very high effective income tax rates and pay more cash income taxes than other businesses. Here is a simplified example of how the 280E penalty affects cannabis operators today:
|Business affected by 280E
|Business is not affected by 280E
|Cost of goods sold
|Deductible business expenses
|Cash after tax
As shown in the example above, a cannabis business with the same amount of revenue and expenses as a traditional business can realize an after-tax cash loss due to Section 280E while a traditional business will generate an after-tax cash profit. However, reclassifying cannabis to Schedule III means that Section 280E will no longer apply to cannabis operators and they will be able to deduct their normal and necessary business expenses to the same extent as traditional businesses. For many cannabis operators, this will have a significant and positive impact on their cash flows and profitability.
In addition to the tax benefits, cannabis rescheduling can be an economic boon for operators in other ways. This could lead to more banks and payment processors doing business with cannabis operators. At present, operators pay higher interest rates on loans and have limited access to financial services. Because of the inherent risks associated with Schedule I substances, insurance policies, where available, provide less coverage and command higher premiums than similar policies for non-cannabis companies. Cannabis rescheduling can significantly reduce operators’ business expenses.
Rescheduling cannabis would also remove federal obstacles to transporting medical cannabis across state lines. This could result in states with better growing climates controlling the market and providing new sales territories for operators in states that typically grow more cannabis than their residents can consume (such as Oregon and California), which in turn could help curb the ongoing illegal market in United State. those countries.
Practical implications of rescheduling
However, rescheduling cannabis will not eliminate all of the challenges facing the cannabis industry today. Just because cannabis is deemed to have acceptable medicinal uses does not mean that all products currently offered in dispensaries will immediately become federally legal, allowing patients to use prescriptions to obtain insurance coverage. The Food, Drug, and Cosmetic Act gives the FDA authority to supervise pharmaceutical products, and rescheduling cannabis will still require FDA approval to be sold in brick-and-mortar pharmacies. Rescheduling cannabis to Schedule III would certainly increase capacity for medical studies, and lead to new drug applications (“NDAs”) being submitted to the FDA for approval of cannabis-based medications that may look very different from existing drugs. Medical cannabis products available. Furthermore, the FDA may seek action against non-FDA-approved cannabis products that market themselves as having medicinal benefits.
The rescheduling of cannabis will also have implications for the adult use market. Schedule III drugs generally require a prescription to obtain, so adult cannabis would still be illegal at the federal level absent additional steps from the federal government. Rescheduling may also discourage efforts to pursue federal legislation or descheduling cannabis, perpetuating conflict between federal and state law regarding adult cannabis use.
Make no mistake: The Department of Health and Human Services letter of August 29, 2023 is the most significant shift in the federal government’s stance on cannabis in more than 50 years. And if the DEA follows in the footsteps of the Department of Health and Human Services and cannabis is rescheduled to Schedule III, there will be significant implications for the US cannabis industry, especially with regard to 280E.
1. Hemp appears in the CSA as marijuana. Previously, Congress elected to exclude hemp, which is defined as a plant hempand any parts of this plant, containing not more than 0.3% delta-9 tetrahydrocannabinol (THC) on a dry weight basis, in the 2018 farm bill.
2. In 2018, the US Food and Drug Administration approved Epidiolex, a cannabidiol derived from cannabis, to treat certain forms of intractable epilepsy in children. The FDA previously approved dronabinol, a synthetic delta-9 tetrahydrocannabinol (THC), for the treatment of HIV-induced anorexia and chemotherapy-induced nausea. Despite the existence of these drugs, the federal government has maintained its position that cannabis has no accepted medical use.
3. For the purposes of this example, we have used a mixed effective tax rate of 30% for illustrative purposes. A cannabis operator’s actual effective tax rate will depend, among other things, on where he does business and the tax classification of the business (for example, corporation versus partnership).
The content of this article is intended to provide a general guide to the subject. It is advised to take the advice of specialists in such circumstances.