Earlier this week, the Department of Justice proposed reclassifying cannabis from Schedule I to Schedule III under the Controlled Substances Act. The move follows an August 2023 recommendation from the Department of Health and Human Services (HHS) to the U.S. Drug Enforcement Administration (DEA) to reevalutate the drug for potential reclassification. DOJ’s proposal represents a paradigm shift in federal cannabis policy and gives cause for optimism across the nation’s growing cannabis industry. It also, however, raises new questions about what exactly cannabis reclassification might mean for existing state cannabis markets. We address some of those issues below.
Understanding CSA Classifications
The Controlled Substances Act (CSA) places all substances which were in some manner regulated under existing federal law into one of five schedules. This placement is based upon the substance’s medical use, potential for abuse, and safety or dependence liability. The classification of a substance’s scheduling can significantly impact the legality and regulation surrounding its use, possession, and distribution.
Schedule I drugs, substances, or chemicals, like cannabis, are defined as drugs with no currently accepted medical use and a high potential for abuse. Some other examples of Schedule I drugs are: heroin, lysergic acid diethylamide (LSD), , 3,4-methylenedioxymethamphetamine (ecstasy), methaqualone, and peyote. The DEA’s proposal, however, recommends reclassifying cannabis as a Schedule III substance. Schedule III drugs, substances, or chemicals are defined as drugs with accepted medical use and a moderate to low potential for physical and psychological dependence. Some examples of Schedule III drugs are: products containing less than 90 milligrams of codeine per dosage unit (Tylenol with codeine), ketamine, anabolic steroids, and testosterone.
At the center of DOJ’s recommended reclassification is the federal government’s new position—for the first time in 50 years — that cannabis is a substance with accepted medical use(s).
Anticipated Timeline for Reclassification
As a federal agency, DEA is subject to a formal rulemaking process. After DEA’s rescheduling proposal is reviewed by the White House, a proposed rule will be published in the Federal Register and subject to a formal comment period. At the conclusion of that public comment period, DEA then has the discretion to hold a formal hearing on the matter before the proposed rule is adopted as a final rule. The final rule will take effect 30 days after publication in the Federal Register. This process can be expected to take up to several months, assuming the final rule is not challenged.
The most significant impact of cannabis reclassification would be the removal of the Internal Revenue Code (IRC) 280E tax burden on cannabis businesses. IRC 280E currently prohibits cannabis businesses from deducting ordinary business expenses because their operations are deemed to involve the “trafficking” of a Schedule I substance. This elevated tax burden has made it much more difficult for cannabis businesses to thrive economically and reduced the likelihood of long-term success for new businesses opening in state cannabis markets around the country.
However, IRC 280E only applies to Schedule I and Schedule II substances—it does not extend to Schedule III substances. Therefore, lawful cannabis businesses will now be able to deduct expenses in the same way traditional, non-cannabis businesses do. Not only will this have a profound economic impact on existing cannabis businesses, but it may also spur industry investment with the newfound prospect of improved profits.
Potential to Improve Access to Banking and Financial Services
While reclassification to Schedule III will remove some of the most precarious regulatory risks associated with banking for cannabis businesses, it is not a cure-all to the current industry dilemma of access to lending and traditional financial services. Even with Schedule III reclassification, cannabis remains illegal under federal law, and financial institutions will remain hesitant to invite the regulatory scrutiny associated with cannabis-related transactions. Most financial institutions are subject to stringent regulations and oversight requiring compliance with protocols like know-your-customer (KYC) and anti-money laundering (AML) rules. These institutions are mandated to report any suspicious activities to the Financial Crimes Enforcement Network (FinCEN) and compelled to report instances of perceived fraud, tax evasion, and illegal drug trafficking.
However, reclassification may draw greater focus to proposed legislation—like the Secure and Fair Enforcement Regulation Banking Act (SAFER) Banking Act—that could have a transformative effect on the way financial institutions interact with cannabis businesses. The SAFER Banking Act would, among other things, resolve the conflict between federal and state laws by providing a safe harbor for banks, credit unions, other financial institutions, and payment processors that provide services to these State-sanctioned businesses, allowing them to operate in the financial mainstream. Although the future of the bill remains uncertain, as recently as last week, Senate Majority Leader Chuck Schumer (D-NY) identified the SAFER Banking Act among a list of legislative priorities for this year. Cannabis reclassification to Schedule III will only improve the odds of substantive cannabis-related banking reform gaining much-needed momentum in Congress.
Removal of Barriers to Clinical Research
Cannabis rescheduling poses tremendous upside for the medical and scientific research communities. Historically, it has been challenging to conduct meaningful cannabis research due, in large part, to its Schedule I status. Current obstacles include the necessity for a single domestic cannabis source, convoluted Schedule I registration protocols, and the scheduling of even non-psychoactive cannabis components, such as CBD, as Schedule I. Researchers must also necessarily navigate a daunting federal regulatory and approval process involving the National Institute on Drug Abuse, (NIDA), U.S. Food and Drug Administration (FDA), and DEA.
Reclassification to Schedule III, however, will result in less onerous research obstacles. Because Schedule III substances are recognized by the federal government as having “accepted medical use”, they are not subject to the same rigid protocols associated with Schedule I substances, for which there is “no accepted medical use.” In turn, medical and scientific research communities should expect reduced bureaucracy and improved supply of cannabis for research purposes.
In conclusion, the proposed reclassification of cannabis from Schedule I to Schedule III under the CSA marks a pivotal shift in federal policy—one that has far-reaching implications for various sectors. Not only would this move acknowledge cannabis’ accepted medical applications, but it would also have an immediate impact on taxation and clinical research, and likely reduce regulatory risks associated with industry access to banking and financial services.
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