Tax Changes for Plant-Touching Firms Amid Cannabis Rescheduling

DEA’s Move to Reclassify Cannabis Could Significantly Lower Tax Burdens for Plant-Touching Operators

The United States Drug Enforcement Agency (DEA) is considering reclassifying cannabis as a less-dangerous substance. This move could significantly impact the federal tax obligations of businesses directly involved with cannabis, often referred to as plant-touching operators. Currently, cannabis is classified as a Schedule I drug under the Controlled Substances Act (CSA), which imposes substantial financial burdens on these businesses due to Section 280E of the Internal Revenue Code (IRC).

Current Tax Challenges Under Section 280E

As a Schedule I drug, cannabis businesses are subject to Section 280E, which stipulates that businesses dealing with Schedule I drugs cannot deduct any expenses other than their cost of goods sold (COGS) for tax purposes. This restriction drastically increases the federal tax burden on cannabis businesses, often resulting in tax rates of 70% or higher. Such high tax rates have hindered the profitability of cannabis businesses, especially in an economic environment where cannabis prices have decreased while inflation has increased.

Potential Relief with Reclassification to Schedule III

The Department of Health and Human Services (HHS) has recommended that cannabis be rescheduled to Schedule III. This change would not only facilitate medical research but also remove the 280E tax burden from cannabis businesses. Once implemented, cannabis businesses will be able to deduct regular business expenses like other normal businesses, significantly increasing their cash flow and overall profitability.

Financial Considerations for Plant-Touching Operators

Business as Usual for Now

Despite the rescheduling announcements, nothing has changed yet. Cannabis businesses must continue to operate as they had before, following current guidelines from the Internal Revenue Service (IRS). Due to the federal illegality of cannabis, these businesses are under increased scrutiny and remain targets for audits.

Future Cash Flow Predictions

With a reduced tax burden, cannabis businesses will have more free cash flow. Business owners should start planning how to utilize these additional funds. Potential uses include purchasing more licenses, paying dividends to shareholders, buying equipment, or expanding business operations that were previously unaffordable due to the constraints of 280E. Revising multi-year financial projections to reflect a non-280E environment is essential.

Planning for Multiple Scenarios

Depending on the timing of the rescheduling, businesses may need to prepare for different scenarios:

Retroactive Application: If rescheduling applies retroactively to the entire tax year, businesses can treat the entire year as a “non-280E” year from an accounting perspective.

• Partial Year Application: More likely, businesses will need to account for expenses incurred before the official rescheduling date under 280E rules and treat expenses incurred after the date in a “non-280E” manner. This dual accounting method will require careful coordination to ensure accurate tax filings.

Given these complexities, it is crucial for cannabis businesses to work with certified public accountants (CPAs) experienced in the cannabis industry to navigate the transition and ensure accurate tax filings.

Industry Impact and Future Outlook

The discontinuation of Section 280E will be a major development for the cannabis industry, enabling businesses to better manage the complex, challenging, and highly regulated market. Preparing now for a 280E-free future is key to successfully navigating the transition, strengthening business health, and lowering overall tax burdens.

The DEA’s move to reclassify cannabis represents a significant step towards reducing financial pressures on plant-touching operators. As the industry anticipates this potential change, cannabis businesses must stay informed and proactive in their financial planning to maximize the benefits of a more favorable tax environment.