On August 29, 2023, the U.S. Department of Health and Human Services (“HHS”), after completing an almost year-long evaluation of cannabis’s current status as a Schedule 1 substance, recommending to the Drug Enforcement Administration (“DEA”) that cannabis be moved from Schedule I to Schedule III. While the DEA has final say on such a change, the HHS recommendation is the biggest signal yet that a change to the long-standing federal classification of cannabis is potentially forthcoming.
Background
The Controlled Substances Act (“CSA”) places drugs into one of five schedules, with Schedule I being the most restrictive and, as such, reserved for the most dangerous of drugs which have no deemed medical value and are consequently federally illegal. Schedule III drugs are currently used for medical purposes, have a moderate to low potential for physical and psychological dependence and include such drugs as testosterone, anabolic steroids, ketamine, and Tylenol with codeine.
The CSA grants the Attorney General rulemaking authority to reschedule substances to another schedule, as long as such transfer is based on a finding of scientific and medical considerations, an evaluation from the HHS, and a finding that the substance fits into the criteria of the intended schedule.
What Will this Change?
Perhaps the biggest effect of moving cannabis to Schedule III will be to the taxation of cannabis businesses. Under Internal Revenue Code Section 280E, no trade or business is allowed to deduct any business expenses (such as rent, utilities, legal costs, and other such expenses) related to the business of selling or producing Schedule I or Schedule II substances, other than the costs of goods sold. This has resulted in a disproportionally higher tax burden on cannabis businesses as compared to other businesses. Rescheduling cannabis to Schedule III would likely result in a significant, positive effect on the cashflow and viability of cannabis businesses as they would be on equal footing with other businesses in their ability to deduct business expenses.
Additionally, we would expect to see significantly increased research on cannabis as well as an increase in cannabis related medicines due to this potential rescheduling. While it is still unclear if the potential rescheduling will affect the cannabis industry’s access to financial and banking services, the risks of operating a cannabis-based business will likely decrease with increased access to cashflow resultant from the change in taxation as described above. This improved cashflow could potentially change the risk analyses of banks, other financial services providers, and even security exchanges.
Key Takeaways
Cannabis is currently legal for medical use in 38 states, three territories, and the District of Colombia and for recreational use in 23 states, two territories, and the District of Columbia. While rescheduling cannabis will not make state-level programs federally legal, it would be, however, a significant step towards the legitimization of the cannabis industry on a national level. Rescheduling cannabis as a Schedule III substance will place cannabis on a level playing field with other businesses when it comes tax policy, and it will provide avenues for increased medical research and development. While there are further steps that must be taken—the DEA will conduct its own independent review of the scheduling of cannabis and the process towards rescheduling will require further administrative actions--the HHS recommendation is a significant step.
