It Ain’t Over ‘til It’s Over: IRS Reminds Taxpayers That Section 280E Applies to Marijuana Companies Until Rescheduling Becomes Law

This is a tax blog. Stay with me – it’s short.

While marijuana advocates celebrate the potential rescheduling of marijuana from Schedule I to Schedule III, the taxman has made clear that marijuana remains a Schedule I substance subject to Section 280E of the Internal Revenue Code. For those who aren’t cannabis tax specialists, 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.

Marijuana is a Schedule I controlled substance and is subject to the limitations of the Internal Revenue Code. As we previously reported, the Justice Department recently published a notice of proposed rulemaking with the Federal Register to initiate a formal rulemaking process to consider rescheduling marijuana to Schedule III under the Controlled Substances Act. That change would remove marijuana from the purview of 280E.

Predictably, a number of cannabis operators couldn’t help themselves and began filing amended returns seeking to avail themselves of what they apparently felt was a change in the law. The response from the IRS is clear:

Taxpayers seeking a refund of taxes paid related to Internal Revenue Code Section 280E by filing amended returns are not entitled to a refund or payment. Until a final rule is published, marijuana remains a Schedule I controlled substance and is subject to the limitations of Internal Revenue Code Section 280E.

The reasoning is simple – marijuana is a Schedule I substance until it is not. While there is currently in place a process that could lead to the rescheduling of marijuana, it has not actually been rescheduled.

Cannabis operators can dream of a time when they will not be subject to the ravages of 280E, but for now that remains just out of grasp, albeit tantalizingly close.

As usual, stay tuned to Budding Trends. We’ll be monitoring all the impacts of rescheduling, including tax implications like this one.

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DOJ Confirms Moving Marijuana to Schedule III; Sidesteps Anticipated Impact on State Cannabis Markets

On May 16, 2024, the Department of Justice (DOJ) initiated the formal rulemaking process to move marijuana to Schedule III of the Controlled Substances Act. The DOJ’s notice of proposed rulemaking unfortunately sidesteps the hard questions about the impact of rescheduling on the existing state adult-use and medical cannabis markets.

Summary of Content

The 92-page notice of proposed rulemaking primarily summarizes and comments on last year’s recommendations by the Department of Health and Human Services to reschedule marijuana, as well as related legal concerns such as compliance with international treaty obligation. The DOJ emphasizes that if marijuana is transferred to Schedule III, “the manufacture, distribution, dispensing, and possession of marijuana would also remain subject to applicable criminal prohibitions under the CSA [Controlled Substances Act],” and that marijuana would remain subject to applicable provisions of the Food Drug and Cosmetic Act.

With respect to the critical question of impact on the cannabis markets, however, the DOJ is silent and merely states that it is “seeking comment on the practical consequences of rescheduling marijuana.”

By way of explanation, the DOJ offers:

“DOJ recognizes this action may have unique economic impacts. As stated above, marijuana is subject to a number of State laws that have allowed a multibillion dollar industry to develop. DOJ acknowledges that there may be large impacts related to Federal taxes and research and development investment for the pharmaceutical industry, among other things. DOJ is specifically soliciting comments on the economic impact of this proposed rule. DOJ will revise this section at the final rules stage if warranted after consideration of any comments received.” (Emphasis added.)

Robust Public Comments Expected

For an industry that has been eagerly awaiting to hear how the DOJ will approach rules that address the interplay between existing state cannabis laws and the complex web of federal laws around Schedule III drugs, the DOJ’s notice is disappointing and may not bode well for a smooth rulemaking process. DOJ will accept public comments for 60 days once the notice of proposed rulemaking has been published in the Federal Register. We can expect robust commentary from cannabis businesses, state regulators, trade organizations and ancillary industries.

Regardless of the outcome of the final rulemaking, it seems apparent that clarity through congressional action is needed more than ever.

Cannabis Rescheduling: HHS Findings and Legal Implications

On August 29, 2023, the U.S. Department of Health and Human Services (HHS) made a groundbreaking recommendation to the Drug Enforcement Administration (DEA) – that cannabis should be rescheduled from Schedule I to Schedule III under the Controlled Substances Act (CSA). This recommendation was made pursuant to President Biden’s request that the Secretary of HHS and the Attorney General initiate a process to review how cannabis is scheduled under federal law. In recent days, the unredacted 252-page analysis supporting the August recommendation was released pursuant to a Freedom of Information Act request. While the DEA is presently reviewing HHS’s recommendation and has final authority to schedule a drug under the CSA, it is ultimately bound by HHS’s recommendations on scientific and medical matters.

Why does this matter? Cannabis1 has been a Schedule I substance since the CSA was enacted in 1971. Substances are controlled under the CSA by placement on one of five lists, Schedules I through V. Schedule I controlled substances are subject to the most stringent controls and have no current accepted medical use. As a result, it is illegal under federal law to produce, dispense, or possess cannabis except in the context of federally approved scientific studies. Violations may result in large fines and imprisonment, including mandatory minimum sentences. Comparatively, Schedule III substances are considered to have less abuse potential than Schedule I and II substances, and have a currently accepted medical use in the United States.

In recent years, nearly all the states within the U.S. have revised their laws to permit medical cannabis use. And 24 states, as well as the District of Columbia, have eliminated certain criminal penalties for recreational cannabis use by adults. However, under the U.S. Constitution’s Supremacy Clause, federal law takes precedence over conflicting state laws. Thus, states cannot actually legalize cannabis use without congressional or executive action, and all unauthorized activities under Schedule I involving cannabis are federal crimes anywhere in the United States.2

Notable Findings in HHS’s Recommendation

For HHS to recommend that the DEA change cannabis from Schedule I to Schedule III, HHS had to make three specific findings: 1) cannabis has a lower potential for abuse than the drugs or other substances in Schedules I and II; 2) cannabis has a currently accepted medical use in treatment in the U.S.; and 3) abuse of cannabis may lead to moderate or low physical dependence or high psychological dependence. HHS considered eight factors to make those findings, some of which include: cannabis’s actual or relative potential for abuse; the state of current scientific knowledge regarding the drug; the scope, duration, and significance of abuse; and what, if any, risk there is to public health. The unredacted analysis provides further insight into HHS’s determination to make the forementioned findings.

CANNABIS HAS A POTENTIAL FOR ABUSE LESS THAN THE DRUGS OR OTHER SUBSTANCES IN SCHEDULES I AND II.

To evaluate cannabis’s potential for abuse,3 HHS compared the harms associated with cannabis abuse to the harms associated with other substances, such as heroin (Schedule I), cocaine (Schedule II), and alcohol.4 HHS reported that evidence shows some individuals take cannabis in amounts sufficient to create a health hazard to themselves and the safety of other individuals and the community. However, HHS also reported evidence showing the vast majority of cannabis users are using cannabis in a manner that does not lead to dangerous outcomes for themselves or others. From 2015 to 2021, the utilization-adjusted rate of adverse outcomes involving cannabis was consistently lower than the respective utilization-adjusted rates of adverse outcomes involving heroin, cocaine, and other comparators. Further, cannabis was the lowest-ranking group for serious medical outcomes, including death. Overall, the data indicated that cannabis produced fewer negative outcomes than Schedule I, Schedule II drugs, and, in some cases, alcohol.

CANNABIS HAS A CURRENTLY ACCEPTED MEDICAL USE IN TREATMENT IN THE UNITED STATES

To determine whether cannabis has a currently accepted medical use (CAMU) in the U.S., HHS evaluated a two-part standard: 1) whether “[t]here exists widespread, current experience with medical use of the substance by [healthcare providers] operating in accordance with implemented jurisdiction-authorized programs, where medical use is recognized by entities that regulate the practice of medicine”; and 2) whether “[t]here exists some credible scientific support for at least one of the medical uses for which Part 1 is met.”

Under Part 1, HHS confirmed that more than 30,000 healthcare providers across 43 U.S. jurisdictions are authorized to recommend the medical use of cannabis for more than six million registered patients for at least 15 medical conditions. The Part 1 findings, therefore, supported an assessment under Part 2. Under Part 2, HHS reported that, based on the totality of the available data, there exists some credible scientific support for the medical use of cannabis. Specifically, credible scientific support described at least some therapeutic cannabis uses for anorexia related to a medical condition, nausea and vomiting (e.g., chemotherapy-induced), and pain.

Overall, while HHS reported that cannabis has a currently accepted medical use in the U.S., the Food and Drug Administration (FDA) underscored that such a finding does not mean that the FDA has approved cannabis as safe and effective for marketing as a drug in interstate commerce under the Federal Food, Drug, and Cosmetic Act.

ABUSE OF CANNABIS MAY LEAD TO MODERATE OR LOW PHYSICAL DEPENDENCE OR HIGH PSYCHOLOGICAL DEPENDENCE.

Lastly, HHS concluded that research indicated that chronic, but not acute, use of cannabis can produce both psychic and physical dependence in humans. However, while cannabis “can produce psychic dependence in some individuals,” HHS emphasized that “the likelihood of serious outcomes is low, suggesting that high psychological dependence does not occur in most individuals who use marijuana.”

Legal Ramifications of New Scheduling

Changing cannabis from Schedule I to Schedule III may potentially allow cannabis to be lawfully dispensed by prescription5 and states’ medical cannabis programs may now be able to comply with the CSA. However, it would not make state laws legalizing recreational cannabis use in compliance with federal law without other legal changes by Congress or the executive branch. Under the change, medical cannabis users may be eligible for public housing, immigrant and nonimmigrant visas, and the purchase and possession of firearms. They may also face fewer barriers to federal employment and eligibility to serve in the military. Researchers would face less regulatory controls, and the DEA would no longer set production quota limitations for cannabis. Because the prohibition on business deductions in Section 280E of the Internal Revenue Code only applies to Schedule I and II substances of the CSA, changing cannabis from Schedule I to Schedule III would allow cannabis businesses to deduct business expenses on federal tax filing.

Importantly, some criminal penalties for CSA violations depend on the schedule of the substance. Thus, if cannabis were to be reclassified as a Schedule III substance, some criminal penalties for CSA violations would no longer apply or be significantly reduced. However, CSA penalties that specifically apply to cannabis, such as quantity-based mandatory minimum sentences, would not change under a new rescheduling.

Many advocates consider HHS’s findings a step in the right direction. Specifically, supporters consider the findings further evidence that cannabis should be removed from the CSA altogether and regulated akin to tobacco and alcohol (referred to as descheduling). Given the momentum of cannabis legalization across U.S. states and breakthroughs in the medical and scientific advantages of cannabis, Congressional or Executive legalization, or – at very least – descheduling of cannabis may be on the horizon.


1 The CSA classifies the cannabis plant and its derivatives as “marijuana.” The CSA definition of marijuana excludes (1) products that meet the legal definition of hemp and (2) the mature stalks of the cannabis plant; the sterilized seeds of the plant; and fibers, oils, and other products made from the stalks and seeds.

2 Congress has granted the states some leeway in the distribution and use of medical marijuana by passing an appropriations rider preventing the Department of Justice from using taxpayer funds to prevent states from “implementing their own laws that authorize the use, distribution, possession, or cultivation of medical marijuana.” Courts have interpreted this as a prohibition on federal prosecution of state-legal activities involving medical cannabis.

3 In its report, HHS defined “abuse” to mean the “intentional, non-therapeutic use of a drug to obtain a desired psychological or physiological effect.”

4 Alcohol is not a scheduled controlled substance, but was used as a comparison because of its extensive availability and use in the U.S., which is also observed for the nonmedical use of cannabis.

5 Although the FDA has approved some drugs derived from cannabis, cannabis is not presently an FDA-approved drug.