DEA’s Marijuana Rescheduling Move Would Trim Business Penalties
DEA's Proposed Rescheduling of Marijuana to Schedule III: Implications for the Industry and Beyond.
The Drug Enforcement Administration’s long-awaited step toward potential acceptance of marijuana at the federal level is a victory for the marijuana industry. It would create significant practical benefits, including reduced civil and criminal penalties, tax benefits, and potential to spur further change.
For decades, marijuana has been classified as a Schedule I controlled substance under the Controlled Substances Act, making manufacture, distribution, and possession of marijuana illegal at the federal level. As a result, thousands of individuals have been fined and incarcerated, and marijuana-related businesses have faced substantial obstacles, even as most states legalized marijuana for recreational or medical use due to conflict between state and federal laws.
The DEA published a notice of proposed rulemaking in May, and proposes to transfer marijuana from Schedule I to Schedule III under the Controlled Substances Act of 1970. While some view the DEA’s new position as a major win for the industry, finalizing the proposed rule remains subject to formal rulemaking, which includes a lengthy public comment period and administrative hearing.
Even after the new rule is adopted, rescheduling marijuana to a Schedule III substance under the CSA won’t equate to marijuana legalization, so the marijuana industry will continue to face various legal, regulatory, and practical obstacles at the federal level.
Legal Implications
The CSA prohibits, among other things, the manufacture, distribution, and possession—or possession with intent to manufacture or distribute—of any controlled substance. This includes Schedule III substances such as ketamine, anabolic steroids, and testosterone, which may not be sold without a DEA license or used without a prescription from a licensed medical practitioner.
However, civil and criminal sanctions—which include fines and incarceration—for offenses involving Schedule III substances are generally far less severe under federal law compared to those involving Schedule I substances.
If marijuana is reclassified as a less dangerous substance under the CSA, it may be more likely that federal law enforcement agencies would deprioritize prosecuting marijuana-related offenses even more so than they have over the past decade as public perception and attention continue to shift towards acceptance of the recreational use of marijuana.
Economic, Tax Implications
Rescheduling marijuana to Schedule III also would have significant economic and tax implications for businesses in the industry. Arguably the most consequential of these impacts is to Section 280E of the Internal Revenue Code of 1986, as amended, which generally provides that no trade or business shall be allowed to take any deduction or credit for amounts paid or incurred if such trade or business traffics in controlled substances under the CSA.
Marijuana companies—and other businesses that sell and distribute other Schedule I and II substances—presently can’t deduct ordinary and necessary business expenses such as rent, insurance, employee compensation, and other similar expenses in computing their federal taxable income.
The result is a much higher effective tax rate for such businesses (many observers have estimated the effective tax rate on marijuana businesses is currently around 70%); however, in its proposed rulemaking, the DEA itself stated that Section 280E would no longer serve as a statutory bar to marijuana-related trades and businesses claiming deductions for ordinary and necessary business expenses if marijuana is ultimately rescheduled to Schedule III.
This potentially would allow businesses in the industry to, for the first time since Section 280E was enacted, deduct ordinary and necessary business expenses from their income, which would result in major tax savings and economic growth.
Banking Reforms
Rescheduling could generate momentum for additional legal and economic changes. Many banks and financial institutions currently are unwilling to provide loans, lines of credit, bank accounts, or credit cards to businesses in the marijuana industry.
Rescheduling marijuana by the DEA could be the spark that spurs Congress to pass the Secure and Fair Enforcement Regulation Banking Act, which would provide a “safe harbor” to banks and financial institutions that service state-sanctioned marijuana-related businesses from criminal, civil, and administrative penalties.
This could open financial institutions to businesses in the marijuana industry, granting those businesses access to critically-needed financial products and services while helping them cut their operating expenses substantially.
Although significant hurdles remain, including the public comment period, administrative hearing, and uncertainty regarding the next administration’s approach to marijuana, rescheduling marijuana to a Schedule III substance would nonetheless be expected to deliver immediate practical and economic benefits to the industry and represent a meaningful paradigm shift in federal marijuana policy.
