On April 30, 2024, the Associated Press announced the U.S. Drug Enforcement Agency (DEA) will move to reclassify cannabis from a Schedule I to Schedule III under the Controlled Substances Act. It is important to note that the move generally requires the DEA to proceed through the rulemaking process. The rulemaking process will involve a public notice and comment period that should take at least sixty days. There is no certainty that the DEA will complete the rulemaking process or a timeframe in which it would occur.
Making Cents of Rescheduling
- As currently drafted, section 280E of the Internal Revenue Code denies tax deductions and credits to any taxpayer engaged in a trade or business that consists of trafficking a Schedule I or II controlled substance within the meaning of the Controlled Substances Act in violation of state or federal law. Final rulemaking and rescheduling could eliminate the tax burden of 280E.
- There is currently no guidance on when taxpayers may benefit from rescheduling. The IRS may take the position that rescheduling would be deemed to relate back to the beginning of a taxpayer’s tax year (taxpayer-favorable). The IRS may take the position that rescheduling has no 280E impact until the first full year in which rescheduling has occurred (unfavorable to taxpayers). Lastly, a middle-ground approach might be a position where taxpayers apportion their disallowance if rescheduling occurs during a taxpayer’s tax year. We might expect a proposed rule to include a January 1 effective date and/or the IRS to include comments suggesting such an effective date.
- There is no guarantee that Congress won’t amend tax law. We could go into the end of the year with proposed tax legislation that would expand 280E to cover Schedule III substances. Similarly, Congress could revisit tax stamps under the Marihuana Tax Act of 1937 or implement an excise tax program. With the looming sunset of tax provisions from the Tax Cuts and Jobs Act, it is unclear what could occur and where Congress may seek to generate tax revenues.
Separately, on March 13, 2024, Green Market Report published an article detailing Ascend's “tax nullification strategy.” Ascend’s CEO did not go so far as to claim the company had nullified 280E. Rather, the company identified a “tax position” and submitted refund claims for their 2020, 2021, and 2022 tax years. The article came on the heels of another Green Market Report from February 29, 2024, detailing a $113M tax refund claim by Trulieve for a tax position related to section 280E.
Making Cents of Tax Refund Claims
- Both Truelieve and Ascend appear to have recorded uncertain tax position liabilities associated with their refund claims. These liabilities generally occur when a company takes a tax position with less than a “more likely than not” level of comfort. This generally means that if the IRS were to audit the underlying tax issue, the company believes it has less than coin-flip odds of being successful. A review of the articles and financial statements suggests that both companies have received tax opinions from law firms at a reasonable basis or substantial authority level of comfort. This generally gives the companies a basis to file a tax return without it later being determined to be fraudulent but may not protect them from interest or penalties upon a later IRS examination.
- Non-publicly traded cannabis companies may be interested in pursuing a similar approach. Those taxpayers should be prepared to pay hefty legal fees for having a law firm first draft a tax opinion, and subsequently defend that position upon IRS exam. On top of those fees, those taxpayers should be prepared to repay any refunds they receive, plus potential penalties and interest. Anyone taking this path is likely holding their breath and hoping the IRS never comes knocking. These positions may reflect a bet-the-farm situation. Proceed with caution!
Our team continues to evaluate what rescheduling will mean for cannabis businesses and the impact that DEA rulemaking might have on established state markets. If you have questions or concerns about how rescheduling may impact your business or the potential for tax refunds, please contact us.
This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.
