Key Takeaways
- The DOJ has proposed rescheduling marijuana from a schedule I to a schedule III substance under the Controlled Substances Act.
- While the rescheduling may not immediately impact the risks associated with banking marijuana-related businesses, it could lead to further legal protections for banks with this clientele.
- Rescheduling marijuana might also alleviate tax burdens for marijuana-related businesses.
On May 16, 2024, the U.S. Department of Justice (DOJ) announced a plan to reschedule marijuana under the Controlled Substances Act (CSA) from a schedule I to a schedule III controlled substance. The Attorney General and the DOJ’s Drug Enforcement Administration (DEA) released a proposed rule that would effectuate the change.[1] This alert discusses potential banking and tax implications.
Background
Since the CSA was enacted in 1970, marijuana has been classified as a schedule I drug, alongside substances like heroin and LSD, and subject to the strictest regulatory and criminal treatment. As attitudes regarding marijuana have liberalized in recent years, federal and state governments have been petitioned to loosen these restrictions.
In October 2022, President Biden asked the Attorney General and the Secretary of Health and Human Services (HHS) to begin the administrative process to review how marijuana is scheduled under the CSA. In response, HHS conducted a scientific and medical evaluation of marijuana and, in an August 2023 letter, recommended that the Administrator of the DEA reschedule marijuana as a schedule III substance. In particular, HHS found that: (1) marijuana has less potential for abuse than the other schedule I and II substances; (2) marijuana has a currently accepted medical use in treatment in the United States or a “CAMU”; and (3) the abuse of marijuana may lead to moderate or low physical dependence or high psychological dependence. Based on this HHS recommendation, the Attorney General initiated the proposed rulemaking.[2]
The Proposed Rule
Under federal law, there are eight factors that determine a drug’s schedule. These include, among others, actual or relative potential for abuse; scientific evidence of its pharmacological effect, if known; the risk to public health; and the drug’s psychic or physiological dependence liability. The proposed rule discusses these factors in depth with respect to marijuana. It also reiterates HHS’s recommendations from August 2023 and notes that the Attorney General determined that marijuana should be rescheduled as a schedule III controlled substance.[3] The DOJ has requested comments on the proposal.
The Bigger Picture
Banking and Anti-Money Laundering
Marijuana-related businesses (MRBs) often struggle to obtain access to financial institutions. Those that service MRBs must have a working knowledge of marijuana and anti-money laundering laws and robust internal controls, and closely follow guidance from the Financial Crimes Enforcement Network (FinCEN). The FinCEN guidance requires financial institutions serving MRBs to conduct specific customer due diligence and to file suspicious activity reports as required. The guidance would remain valid upon any rescheduling.
Financial institutions that are newly interested in banking MRBs, should note that the proposed rule itself would not likely impact related legal risks, including the risk of liability for money laundering. This is especially true because recreational marijuana would remain illegal under federal law.
However, if the proposed rule becomes law, this could trigger further legalization of marijuana at the federal level. For years, variations of a bill—the Secure and Fair Enforcement (SAFE) Banking Act—attempting to protect financial institutions serving MRBs have risen and fallen in Congress. In September 2023, another variation was introduced in the Senate, but since a December 2023 committee meeting on the bill, no further action has been taken. The proposed rule, if passed, could give the SAFE Banking Act the leverage it needs to become law. If finalized, the proposed rule might also prompt the release of updated MRB guidance from FinCEN. These developments could also be impacted by the relevant administration in power.
Tax
Although the rescheduling of marijuana itself may not have an immediate impact on the provision of banking services to MRBs, it could produce immediate (or at least near-term) tax benefits for MRBs.[4]
Under the current regime, Section 280E of the Internal Revenue Code (the “Code”) prohibits deductions or credits for businesses that traffic in schedule I or II controlled substances. Despite this, income from activities considered illegal—such as selling marijuana products—is included in the calculation of gross income, upon which business owners must pay U.S. federal income tax. This framework can have a significant, negative impact on a business’s ability to be profitable. For example, an MRB’s tax bill may be significantly larger than a similarly situated non-MRB.[5] Moving marijuana to schedule III would resolve this issue for many businesses.
On June 28, 2024, the IRS published a notice reminding taxpayers that the proposed rule does not alter Section 280E and unless and until the DOJ reschedules marijuana, taxpayers cannot file an amended return or claim a tax refund based on the anticipated change. Further, it is presently unclear whether the proposed rule, if finalized, would entitle taxpayers to refunds for taxes paid in a prior taxable period due to Section 280E’s limitations.
Recognizing that taxpayers in the marijuana industry contend with a nuanced landscape, the IRS has published legal guidance in Q&A form. The Small Business/Self-Employed division of the IRS also implemented an MRB-related strategic initiative in 2021 to aid IRS examiners in the navigating MRB audits. If the DOJ’s proposed rule is finalized, we may expect additional guidance from the IRS for MRB taxpayers.
[1] The CSA authorizes the Attorney General to reschedule controlled substances. Although the Attorney General has generally delegated this authority to the Administrator of the DEA, the Attorney General also retains this authority.
[2] The Attorney General also consulted with the Office of Legal Counsel (OLC) on certain legal questions relating to the HHS recommendation. The OLC confirmed that neither the international Single Convention on Narcotic Drugs nor the CSA required keeping marijuana on schedule I, and that, as needed, the DEA could satisfy any gap between the drug’s schedule and international obligations through specific regulatory restrictions.
[3] The proposed rule would capture marijuana as listed in 21 CFR 1308.11(d)(23), marijuana extracts as defined in 21 CFR 1308.11(d)(58), and delta-9 THC derived from the marijuana plant, but would not apply to synthetically derived THC, which would remain a schedule I substance. This rulemaking would also not impact hemp or marijuana’s regulation under the Food, Drug, and Cosmetic Act.
[4] Because MRBs struggle to find bank partners, they often operate heavily in cash. MRBs should be mindful of their obligation to report cash receipts of $10,000 or more on IRS Form 8300. Failure to do so may result in penalties. The potential rescheduling of marijuana under the CSA is not expected to affect this reporting requirement.
[5] The Taxpayer Advocate Service provides an example of the disparity in tax burden between MRBs and non-MRBs.
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