Tax Implications Of Reclassifying Cannabis As A Schedule 3 Controlled Substance –
24 September 2023
Duane Morris LLP
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On August 29, 2023, the U.S. Department of Health and Human
Services responded to President Biden’s October 2022 call for a
federal review of marijuana
scheduling: The drug should be reclassified as a
Schedule 3 controlled substance. Below, we explore questions on the
tax ramifications to the cannabis industry if marijuana is
reclassified as such.
Frequently Asked Questions on Cannabis Reclassification
What Is the Impact on the Application of Section 280E to the
Industry If Marijuana Is Reclassified As a Schedule 3 Controlled
Substance?
Answer: Section 280E provides that:
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.
Section 280E basically bars almost all of a company’s
ordinary and necessary business expenses in determining taxable
income. This ban only applies to a taxpayer engaged in the business
of “trafficking in controlled substances” meaning
substances listed in Schedules 1 and 2 of the Controlled Substances
Act. If marijuana is reclassified as a Schedule 3 controlled
substance, Section 280E will not apply to that company’s tax
return. Consequently, the company would no longer be banned from
deducting on its federal tax return its ordinary and necessary
business expenses.
How Would Rescheduling Effect State Tax Returns?
Answer: More than a dozen states have already
“decoupled” from Section 280E, meaning that it does not
apply in those states. As to most other states, their tax returns
“mirror” the federal return. So if Section 280E no longer
applies to your federal return, it will not apply to your state
return.
If Marijuana Is Reclassified As a Schedule 3 Controlled
Substance, When Will the Law Take Effect for Tax Purposes?
Answer: We do not know, but hopefully the
reclassification would be resolved sometime in 2024. The effective
date for tax purposes could possibly be January 1, 2024, in which
case all companies that file on a calendar year basis could take
full advantage of their ordinary and necessary business expenses on
their 2024 federal income tax returns.
What About Past Taxes That Were Paid As a Result of the
Application of 280E? Would Those Taxes Be Forgiven If 280E Is No
Longer Applicable?
Answer: We do not know if the rescheduling will
be retroactive, but it is unlikely that would be the case.
Consequently, there would be no relief from past taxes paid under
the 280E regime.
If I Owe Past Taxes Due to 280E Will the IRS Continue to
Collect a Tax That No Longer Exists? How Do I Deal with That?
Answer: It is likely that the IRS would
continue to try to collect past taxes due under the 280E regime. If
that is the case, then a company should seek relief in the form of
either installment agreement or a partial pay installment
agreement.
If a Company Has a Net Operating Loss from Prior Years Due to
the Section 280E, Can It Carry That Forward to a Year Where
Marijuana Is Reclassified As a Schedule 3 Controlled Substance and
280E No Longer Applies?
Answer: The loss was not deductible when it was
incurred only because of Section 280E’s prohibition in that
earlier tax year. In the later year to which the loss would be
applied, assuming reclassification to Schedule 3 occurs, there is
no prohibition to limit deductions of cannabis business, so perhaps
the carry forward loss would be deductible. But this is a complex
question for which we would expect IRS guidance.
There Is Litigation in the Courts Challenging the
Constitutionality of Section 280E. What Happens to the Taxes Paid
If 280E Is Declared Unconstitutional?
Answer: It is hard to say how the courts will
rule on this issue. But one thing is for sure: There is a statute
of limitations for filing a claim for refund, and if a claim is not
filed within that statute (generally the later of two years after
the date of payment of the tax or three years from the date the tax
return was filed) there will be no refund available. So, file
claims for refund now―a “protective claim”―to
avoid losing out if 280E is declared unconstitutional.
About Duane Morris
Duane Morris attorneys represent businesses and individuals at
every level of the cannabis supply chain. We assist our
cannabis-related clients in understanding and assessing the federal
and state regulatory framework for cannabis; applications for
licenses to operate and related administrative matters; commercial
litigation; negotiating and documenting investments, joint
ventures, and mergers and acquisitions; conducting due diligence on
the targets of such transactions; federal, state and local tax
issues; day-to-day regulatory advice and general business counsel;
and labor and employment, including workplace training and
litigating workplace claims.
For More Information
If you have any questions about this Alert, please
contact Thomas
W. Ostrander, any of the attorneys in our Cannabis Industry Group, any of the attorneys in our Tax Group or
the attorney in the firm with whom you are regularly in
contact.
Disclaimer: This Alert has been
prepared and published for informational purposes only and is not
offered, nor should be construed, as legal advice. For more
information, please see the firm’s
full disclaimer.
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