If marijuana is rescheduled as a Schedule III controlled substance, Section 280E will not apply to that company’s tax return.
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 rescheduled as a Schedule III controlled substance. Below, we explore questions on the tax ramifications to the cannabis industry if marijuana is rescheduled as such.
Frequently Asked Questions on Cannabis Rescheduling
What Is the Impact on the Application of Section 280E to the Industry If Marijuana Is Rescheduled As a Schedule III 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 I and II of the Controlled Substances Act. If marijuana is rescheduled as a Schedule III 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 Rescheduled As a Schedule III Controlled Substance, When Will the Law Take Effect for Tax Purposes?
Answer: We do not know, but hopefully the rescheduled 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 Rescheduled As a Schedule III 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 rescheduling to Schedule III 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.
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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.
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