Tax Benefits and R&D in Sight as DEA Recommends Cannabis Reclassification

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In a recent move, the U.S. Drug Enforcement Administration (“DEA”) pushed for a historic shift in American drug policy by proposing to reclassify cannabis from Schedule I of the Controlled Substances Act to a lower risk Schedule III. A significant change in how the government views the safety and use of cannabis around the country, the reclassification (if approved) could open the door to tax benefits for thousands of U.S businesses. 

History of the Controlled Substances Act

Initially passed in 1970 as part of the Comprehensive Drug Abuse Prevention and Control Act, the Controlled Substances Act (“CSA”) established a federal classification system to regulate the manufacture, importation, possession, use, and distribution of certain substances and chemicals. The act created five schedules, I to V, in order of highest potential for abuse and likelihood of associated dependency. 

Since the act was passed, cannabis has been classified as a Schedule I substance. The new proposal includes an interim rule reclassifying the drug to Schedule III, which includes substances such as steroids and Tylenol with Codeine. In addition to the acknowledgement of its potential medical benefits, the reclassification of cannabis has tax advantages, too – excluding it from the requirements of Section 280E.

Section 280E and R&D Tax Credits

Section 280E of the United States Code of Federal Regulations, which governs how taxpayers are allowed to treat expenditures in connection with the illegal sale of drugs, prevents taxpayers from claiming any deduction or credit for business activities connected with selling controlled substances. This directly impacts any business trafficking Schedule I or Schedule II substances regulated by the CSA, including cannabis. Historically, Section 280E has penalized innovative U.S. cannabis businesses as they are required to show income from the sale of cannabis but disallowed from deducting “ordinary and necessary” business expenses or claiming valuable credits, including the R&D Tax Credit. 

As a result, thousands of U.S. cannabis businesses are barred from claiming the R&D Tax Credit, regardless of whether cannabis is legal in the company’s state of operation. If approved, the DEA’s proposal will allow cannabis companies to deduct business expenses and receive the benefit of claiming the R&D Tax Credit, introducing a new industry to the credit with a plethora of innovative activities.

 

 

What is Next?

The road to reclassification is a long one and has been attempted before with no success. However, recent pushes from government agencies have sparked new optimism that this long-awaited change could be on the horizon. The proposed regulation was submitted to the Federal Register on May 16, 2024, initiating a formal procedure that includes a 60-day public review period followed by an administrative law review. If the DEA acts swiftly, the change could be made in time for the spring tax season.

We anticipate more will come on the legislative rules governing cannabis and the IRS will likely issue its own guidance regarding its treatment of the change.

Matt Davenport
Director of Research & Development (R&D)

R&D Tax Credit expert, with a deep understanding of tax regulations, Davenport has more than 10 years’ experience helping businesses maximize and substantiate various complex tax credit incentives. Davenport holds a Bachelor of Business Administration (BBA) in Business Management & Entrepreneurship from Texas Tech University and has extensive tax credit consultancy experience, successfully leading hundreds of R&D Tax Credit engagements, R&D Tax Credit audits, and tax credit planning services.