Navigating the Impact of Section 280E and the DEA’s Proposed Marijuana Rescheduling

The cannabis industry is well-acquainted with the financial burden imposed by Section 280E of the Internal Revenue Code of 1986. This section significantly raises the cost of business by prohibiting deductions for expenses associated with “trafficking” in marijuana—deductions that other traditional businesses can claim for wages, rent, utilities, insurance, and more.

On May 16, 2024, the Drug Enforcement Administration (DEA), part of the Department of Justice, issued a Notice of Proposed Rulemaking (NPR) to reclassify marijuana from Schedule I to Schedule III of the Controlled Substances Act (CSA). Rescheduling marijuana to Schedule III would make Section 280E inapplicable to cannabis businesses, though it would still apply to other substances like heroin, LSD, and Ecstasy.

Preparing for the Future of Rescheduling

Though the path to rescheduling may be lengthy and complex, it is anticipated to happen eventually. The critical questions are “when” and “how can cannabis businesses prepare?” The NPR does not specify the effective date of rescheduling or its impact on tax treatment of marijuana business expenses, but businesses can take proactive steps now to prepare.

Taxes and Timing of Rescheduling

The effective date of rescheduling is pivotal for tax purposes. Once rescheduling occurs, expenses related to cannabis businesses paid or incurred after this date will become deductible, as Section 280E will no longer apply.

Section 162 of the Code allows for the deduction of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Section 7701(a)(25) of the Code defines “paid or incurred” based on the taxpayer’s accounting method.

There are two primary accounting methods: the cash method and the accrual method. Under the cash method, expenses are deductible in the taxable year they are paid. Under the accrual method, expenses are deductible when: (1) all events establishing the liability have occurred, (2) the liability amount is determinable with reasonable accuracy, and (3) economic performance has occurred—meaning the related property or service has been provided or used.

Deductions for Marijuana-Related Expenses

The effective date of marijuana rescheduling will be established by final regulations issued by the DEA. Generally, the effective date of such regulations is the publication date in the Federal Register, although it can be later (e.g., thirty days after publication).

For tax purposes, after the effective date, Section 280E will no longer apply, allowing deductions for expenses related to cannabis businesses paid or incurred after this date. The effective date for Section 280E purposes could potentially differ from other purposes.

Cannabis businesses might consider delaying the payment or incurring of expenses subject to Section 280E until the effective date. For those using the cash method, this might mean postponing payments; for those using the accrual method, it could mean delaying the incurrence of expenses.

Protective Refund Claims

While the effective date for rescheduling is likely prospective, it could be retroactive concerning Section 280E applicability. This would mean Section 280E no longer applies to past taxable years, enabling businesses to claim refunds for previously disallowed deductions.

Taxpayers must generally file refund claims with the IRS within three years of the related tax return filing or two years of paying the tax, whichever is later. To preserve the right to refunds, cannabis businesses might file protective refund claims, which suspend the refund statute of limitation until a complete claim can be filed if rescheduling is retroactive.

The Bottom Line

The tax rules governing when expenses are paid or incurred and the filing of past or prospective claims can be complex. Following rescheduling, or possibly before, the IRS may issue guidance on how rescheduling impacts Section 280E and the deduction of marijuana-related expenses. Meanwhile, cannabis businesses should consult with tax professionals to strategically time expenses and submit necessary documentation to secure potential refunds for taxes paid under Section 280E.