How the Biden Marijuana Shift Could Impact Taxes

In a significant shift in United States drug policy and regulation, the Biden administration is planning to reclassify marijuana as a less dangerous drug. The proposed reclassification, led by the U.S. Drug Enforcement Administration (DEA), acknowledges the medical benefits of cannabis and its lower potential for abuse compared to other controlled substances.

The White House Office of Management and Budget is currently reviewing this proposal. If approved, marijuana will be moved from being a Schedule I drug, alongside substances like LSD and heroin, down to a Schedule III classificaiton. 

• However, this does not mean that marijuana will become legal for recreational use nationwide. 
• Instead, the move would facilitate research and recognize the evolving acceptance of cannabis in the U.S.

Of course, this decision has its critics, but it's worth noting that the change would also impact federal income tax breaks for many cannabis businesses.

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Biden on marijuana reclassification

Under federal law, marijuana is currently classified as a Schedule I controlled substance, making it illegal to grow, transport, or sell. The Biden proposal would reclassify the substance to Schedule III alongside substances like steroids.

Some critics express concerns about potential side effects and marijuana purportedly being a "gateway drug." Proponents argue that rescheduling marijuana is a step in the right direction, emphasizing the need to align federal policy with the growing acceptance and legalization of cannabis at the state level. 

President Biden initially called for a review of federal marijuana laws a couple of years ago, a move paired with efforts to pardon individuals convicted of marijuana possession offenses. Meanwhile, 38 states and the District of Columbia have approved marijuana for medical use. Close to half of U.S. states have approved recreational use.

Cannabis rescheduling 280E tax

Lessening federal regulations concerning marijuana could reduce the tax burden on cannabis businesses. That’s because a significant tax provision cannabis operators in the U.S. deal with is Section 280E of the Internal Revenue Code.

Section 280E restricts cannabis businesses from claiming tax credits and deductions for expenses incurred in their business operations. Businesses cannot deduct expenses associated with the "trafficking" of Schedule I or II substances.

Consequently, Section 280E disallows deductions for many ordinary business expenses of cannabis businesses, like rent and employee compensation, when calculating federal taxable income. This limitation can result in higher tax bills for those businesses. Data show that in 2022, marijuana businesses paid nearly $2 billion more in federal taxes compared to “ordinary businesses.”

State cannabis tax

However, some states have taken steps to alleviate this burden by decoupling from 280E. This means cannabis businesses operating in certain states can deduct certain business expenses on state tax returns. 

• For example, Virginia, Massachusetts, Missouri, and Maryland are recent states that have excluded IRC 280E from their tax codes. 
• But, according to the cannabis advocacy organization the Marijuana Policy Project, several other states, including but not limited to California, Colorado, Connecticut, New York, and Oregon, have eased state tax restrictions related to 280E.

It’s important to note that not all states have implemented decoupling measures. So, without the DEA marijuana reclassification change, cannabis businesses in those states would remain subject to the full impact of Section 280E on federal and state tax bills.

Biden marijuana proposal: Bottom line

As the DEA moves forward with the regulatory process, which could take some time, stakeholders should monitor any developments. 

For example, on May 1, Sen. Cory Booker (D-NJ), Majority Leader Chuck Schumer (D-NY), and U.S. Senate Finance Committee Chairman Ron Wyden (D-Ore.) reintroduced the Cannabis Administration and Opportunity Act. The legislation proposes to end the federal prohibition of cannabis.

In the meantime, cannabis businesses should continue to navigate Section 280E, seeking guidance from qualified tax professionals to optimize tax strategies and ensure compliance with applicable and evolving regulations.

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