On Tuesday, April 30, the Associated Press reported that the Drug Enforcement Administration (DEA), will move to reclassify marijuana from a Schedule I drug to a Schedule III drug.  DEA’s move comes several months after the Department of Health and Human Services (HHS) recommended to DEA (pdf) that marijuana be rescheduled under the Controlled Substances Act (CSA).

What Does It Mean To Reschedule a Drug?

Under the CSA, drugs are classified into five schedules based on the drug’s acceptable medical uses and the drug’s abuse or dependency potential.  A drug’s abuse or dependency potential is typically the determinative factor in scheduling decisions.

• Schedule I drugs are drugs, substances, or chemicals that currently have no accepted medical use and a high potential for abuse. Schedule I drugs include heroin, LSD, ecstasy, peyote, and methaqualone (i.e., Quaalude).  Marijuana is currently classified as a Schedule I substance.
• Schedule II drugs include substances that have a high potential for abuse, are considered dangerous, but have some medically accepted uses. Drugs in Schedule II include cocaine, methamphetamine, methadone, oxycodone, and fentanyl.
• Schedule III drugs have a moderate to low potential for physical and psychological dependence and include drugs such as Tylenol with codeine, ketamine, anabolic steroids, and testosterone.
• Schedule IV and V drugs are substances that have a low potential for abuse and low risk of dependence. Common Schedule IV drugs include Xanax, Valium, Ativan, Ambien, and Tramadol.  Schedule V drugs include Robitussin AC (codeine), Lomotil, Motofen, and Lyrica.

DEA’s first step towards rescheduling marijuana from Schedule I to III represents a seismic policy shift, as it would be the first time DEA has recognized any legitimate medical purpose for marijuana.  DEA’s move also signals the Administration recognizes that marijuana has only a moderate to low potential for abuse.

This is a far cry from how marijuana has been portrayed over the years, from the Reefer Madness warning that marijuana leads to “debauchery, violence, murder, suicide, and … hopeless insanity” to warnings in the 1990s that marijuana has “adverse effects on reproductive organs, causes heart malfunctions, and … acceleration of the aging process.”

Why It Matters … Taxes!

DEA’s policy shift is significant for a host of reasons, but perhaps the most important impact of rescheduling marijuana is that it extricates cannabis businesses from the Internal Revenue Code’s ban on deducting business expenses for cannabis companies.  26 U.S.C. § 280E states “[n]o 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 [ … ] consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act).”

Assuming DEA successfully completes the rulemaking process to codify the schedule change (which will take several months at minimum), cannabis-related businesses, whether in medical or recreational markets, will be able to operate their businesses within the same tax code that governs all other business endeavors across the United States.  Once rescheduled, cannabis businesses will be able to deduct normal overhead expenses, including, among other things, advertising expenses, wages and salaries, and travel expenses.

With better balance sheets comes more opportunities (and less risk) for investors and financial institutions to enter the fray.  Though the impact of rescheduling on access to conventional banking services is less clear, DEA’s policy shift also provides some momentum for Congress to consider seriously the pending Secure And Fair Enforcement Regulation Banking Act (SAFER Banking Act), which is cosponsored by 35 Senators (28 Democrats, 4 Republicans, and 3 Independents).  If enacted, the bill would provide more protections for federally regulated financial institutions that serve state-sanctioned cannabis businesses, including reclassifying proceeds from state-approved cannabis transactions as lawful under otherwise applicable anti-money laundering laws.