Cannabis Rescheduling FAQ: What Now?

While many have long anticipated the Drug Enforcement Administration’s (DEA) proposal to reclassify cannabis in a less dangerous category and acknowledge its medical potential under the Controlled Substances Act (CSA), the finish line remains fluid. There’s still an at least monthslong rulemaking process that needs to take place before it can take effect and possible roadblocks to its finalization and implementation.

And though many have recognized the significance of the DEA’s alignment with the Department of Health and Human Services’ (HHS) recommendation to move cannabis to Schedule III from Schedule I, some ramifications of the move are still unknown, and it does not legalize cannabis under federal law.

But Jonathan Havens, Baltimore office managing partner and Cannabis Law practice co-chair at Saul Ewing, said despite the limitations of rescheduling and the work ahead, it’s important to keep this in context and remember—this is a very big deal.

“The headline to me is the federal government is poised to make the most significant controlled substances reform since really the enactment of the Controlled Substance Act,” Havens said of the 50-plus-year-old law. “To have a president say that federal agencies must expeditiously evaluate the appropriate scheduling of marijuana … President Biden issued his executive order less than two years ago … and to have HHS issue its findings less than a year later .... By Washington standards, that's lightning quick, particularly with something as like marijuana policy, which has essentially been the same for 50-plus years.”

Since the news broke April 30 that the DEA would initiate the rulemaking process to reschedule cannabis, aligning with HHS’s recommendation, many have speculated what it would and wouldn’t mean for state-legal cannabis markets, banking legislation, federal legalization and more.

While rescheduling cannabis would mean less restrictions for the plant and industry, it would still remain a scheduled drug, unlike alcohol and tobacco, which are not scheduled under the CSA.

“Schedule III doesn't legalize weed. In fact, it just means it has a medical benefit and you can buy it with a prescription,” said Sander Zagzebski, co-chair of Clark Hill’s Cannabis Practice. “But none of the providers of cannabis are licensed pharmaceutical companies. They’re not FDA regulated, and of course none of the recreational folks are getting a prescription of any type. So cannabis is not going to be complying with that regime.”

The most immediate impact of rescheduling will be that Internal Revenue Code Section 280E will no longer apply to plant-touching, state-legal cannabis companies, and they will be able to take normal business tax deductions afforded to other industries. The inability to take advantage of credits or deductions other than those for costs of goods sold has long been a barrier to profitability. And, under Schedule III, the currently accepted medical use of cannabis is recognized, and research of the potential of the plant should improve.

But, as noted before, rescheduling does not legalize cannabis at the federal level, and, as many have pointed out, does not, on its own, achieve criminal justice reform.

Cannabis Business Times spoke with legal experts in the industry to get their take on some frequently asked questions about the rescheduling knowns, the unknowns, major implications and what cannabis businesses can do now to prepare.

How soon could the rulemaking process be finalized and cannabis officially be categorized as a Schedule III substance?

“It's possible this could all get done before November 5 [Election Day 2024], but the stars would really, really need to align for that to happen,” Havens said. “As of [May 2], it was 187 days to the election. Two-hundred days is kind of a rough target for [rescheduling]. Number one, the OMB [Office of Management and Budget] needs to consider it. We would expect that to take up to 90 days, although the Biden administration has this on the fast track so the hope is that process could happen much sooner.”

After the DEA publishes the proposed rule in the Federal Register, there is a public comment period that can be 30 to 90 days, and also an opportunity for someone to challenge the rule and trigger an administrative law hearing.

“We fully expect that there are going to be challenges, not necessarily a legal challenge (although that’s certainly possible), but an administrative law judge hearing request on the rule. We definitely expect challenges from people like Kevin Sabet and the SAM group, Smart Approaches to Marijuana,” Havens said. “I find that almost impossible to believe that there's not going to be a hearing. I expect there's going to be at least one legal challenge to this … and how quickly does that get resolved?” [Editor’s note: SAM announced that it is raising money for a legal fund to challenge cannabis rescheduling. “If the Administration decides to move marijuana to Schedule III, then SAM is prepared to pursue legal action,” the organization wrote on its website.]

Then, the DEA must review those comments and challenges. There is no specified timeframe for hearings nor for how long the DEA review process will take. Once the final rule is published, there’s usually a delayed implementation for 30 days until it becomes effective, Havens said.

“When you add all that up, a very, very expedited estimate is around 200 days, but that’s not withstanding litigation and a hearing process,” he said. “This could take years. It doesn't give me pleasure to say that, but it could take four years to get this done.  My sense is that it won’t take that long but it’s important to be candid about the possibilities.”

When was the last time DEA rescheduled a substance?

“DEA actually issues scheduling orders quite often, sometimes to schedule a drug, sometimes to move it from one schedule to another, and sometimes to remove it from control altogether,” Havens said. “Rescheduling orders are rarer, although they do occur. 

“Interestingly, in September 2018, DEA issued a scheduling order to place Epidiolex, an FDA-approved drug that contains cannabidiol (CBD), in Schedule V. Until that time, Epidiolex, which contains CBD derived from cannabis and no more than 0.1 percent tetrahydrocannabinols, had been a Schedule I controlled substance. About 18 months prior, DEA placed FDA-approved oral solutions containing dronabinol in schedule II of the CSA. A few years prior to that, in August 2014, DEA increased the control of hydrocodone combination products from Schedule III to Schedule II. Ultimately, though, the marijuana rescheduling move from DEA is significant because marijuana itself has been a Schedule I drug since the 1970s.”

What happens if DEA doesn’t issue the final rule in 2024/early 2025? Could rescheduling be overturned if the administration changes after the 2024 election?

“When things are pending at OMB, and there's a change in administration, I don't care who you are, whether you're Biden, whether you're Trump, it's very commonplace that those things will get wiped out,” Havens said. “It's not necessarily retribution, it's just these aren't the incoming administration's rules and priorities, necessarily. If the rule has already been finalized, it’s a lot harder to unpack it than if it's in a pending stage. So, if it's not finalized before January, and if Biden loses [the election], I worry about the rule’s chances of taking effect. So, could it still get done between November and January? It's possible, but if it's not done by the time a new president takes office, it's absolutely possible that this gets killed. How likely, we don't know. There's not always predictability with these things. That’s why there's this big push to get it done before November 5.”

What does potential rescheduling mean for the SAFER Banking Act, and is there still a need for it?

“SAFER Banking or some sort of banking fix is still needed,” Havens said. “We have Schedule I, which means, by definition, high potential for abuse and no current accepted medical use. Schedule III means currently acceptable medical use. There is, as FDA has found, some abuse potential, but it can be mitigated, so to speak, through the controls set forth in the Controlled Substances Act. This is not forced federal legalization. This is simply ending the federal prohibition on cannabis for all purposes. It will still be up to states to decide what's legal within their boundaries. Schedule III, while certainly less restrictive than Schedule I, is not unrestricted. It is heavily restricted. [Cannabis businesses] are still not going to be complying with the strictures of Schedule III of the Controlled Substances Act. And banks could say are you compliant with all federal, state, and local laws? And they're still not going to be able to make that certification, just like they're not able to now.  So yes, a banking fix would still be needed, even post Schedule III.”

What were the prospects of SAFER Banking before rescheduling, and do you think that will change now that the DEA has recommended it?

Editor’s note: CBT previously reported that “legislation to provide safe harbor to financial institutions wishing to service the cannabis industry—the Secure and Fair Enforcement Regulation (SAFER) Banking Act—has advanced as far as it ever has in the U.S. Senate, which is leading the charge this Congress.” Read this report on the state of federal cannabis reform in 2024 for more background.

“My hope is that with increased discussion around Schedule III and highlighting the continued need for it, that maybe some members who wouldn't have supported [cannabis] when in Schedule I might come around to say, ‘OK, if it's legal for some purposes or at least legal in theory, then I can get behind it,’” Havens said. “I am optimistic. Am I betting on it happening before the end of the year or telling anybody else to bet on it? I'm not.

“As far as the prospects, we heard yesterday [May 1], [Sen.] Chuck Schumer’s [D-N.Y.] latest plan is to attach it to the FAA reauthorization bill. [Sen. Mitch] McConnell [R-Ky.] has come out and said he's opposed to that. It’s hard to understand exactly the prospects of success and how likely it is that it would pass. The House has passed even more robust reform than SAFER Banking, but the Senate's always been the stumbling block. Some have asked me, ‘Well, does Schedule III light a new fire under the Senate to get this done?’ It is as important as ever. They still need access to banking–and not to denigrate the important role that the smaller regional banks and credit unions have played, because frankly, they're the only game in town—but businesses need to be able to take advantage of robust banking with lending, not just depository services. Hopefully it paves the way to U.S. capital markets access. SAFER Banking still would need to pass in order to get a lot of these financial institutions off the sidelines.”

What does this mean for state-legal cannabis businesses? Can they expect more federal oversight, from the Food and Drug Administration or other agencies?

“Step one is just confirming that none of the federal agencies, the FDA being the primary one, and the DEA, that they're not going to seek to do any rulemaking around cannabis,” Zagzebski said. “The likelihood of that happening is low in the short run, but the text of the law does give them that authority. I think states are going to keep doing what they've been doing. In other words, the state regimes have all focused on activities within the state, and the states have relied on the federal government basically stepping aside.”

“Schedule III is a really good first step, but if Congress doesn't get involved pretty quickly, if you think it was messy in Schedule I, it's going to get real messy in Schedule III without some smoothness at the federal level or at least guidance,” Havens said. “State regulated markets right now are robust and are working by and large, and I think one very large mistake that could be made is for the feds to come in and say, ‘Alright, states, good job. We'll take it from here.’ I don't even think that's a possibility for a few reasons. Number one, there's not a specific delegation of authority from Congress for FDA, DEA or really any other agency right now to all of a sudden actively regulate the cannabis market.

“They need money to do it, whether that's appropriations from Congress or user fees from industry or some combination thereof. And these agencies don't have an abundance of regulators to throw on new issues, particularly with an industry as large and as complex as cannabis. Forty states have a medical program and 24 of those have an adult-use program.  This is not a small issue to tackle.”

Is there still a need for federal guidance from the attorney general’s office on how federal agencies will treat cannabis, similar to the Cole Memo issued in 2013?

RELATED: Former Deputy Attorney General James Cole Weighs in on Cannabis Rescheduling and What’s Next

“Perhaps, but I certainly don't think they're going to do so while the Canna Provisions lawsuit is pending, the one that David Boies* is lead counsel on, because it would seem odd for [the Department of Justice] to be fighting back against that case and then say, ‘Hey, if and when Schedule III happens, you’re A-OK to do the following things,’” Havens said. “I think it would really take the wind out of their sails in the case.”

[*Editor’s note: As CBT previously reported, a coalition of cannabis businesses in Massachusetts, represented by law firms Boies Schiller Flexner LLP and Lesser, Newman, Aleo & Nasser LLP, announced at the end of October that they had filed a lawsuit against Attorney General Merrick Garland over the enforcement of the CSA. The DOJ noted in its motion to dismiss the case in February that “It is not for the courts to disrupt or get ahead of that administrative process.” The DOJ’s argument outlined three primary reasons, based on past legal precedent and state and federal statutes, why the complaint should be dismissed, indicating that plaintiffs: “lack standing to challenge the CSA’s prohibition of marijuana activities;" “fail to state a claim that the CSA exceeds Congress’ power under the Commerce Clause and Necessary and Proper Clause;” and “fail to state a claim that the CSA violates substantive due process.”

“I do think DOJ could issue Cole Memo 2.0, but unless and until that litigation is resolved, I'm not so sure we're going to be hearing much from the DOJ,” Havens said. “I do think we're going to need guidance from somebody because if we're relying on Congress, it's difficult to get a lot done in Congress these days, and the notion that there's all of a sudden going to be a quick, sweeping piece of legislation that addresses all of these things like interstate commerce and who has oversight and setting up, if this is the route they go, a cannabis division at FDA and giving DEA new authorities, it just seems like that is a long way off, much longer to me than the rulemaking process at DEA.

“One of the Cole Memo enforcement priorities was no interstate commerce or no movement between states, even if you're going from one adult-use state to another. So we're going to need Congress to address that. I suppose it's possible we could get it through unenforceable guidance, but if there's a change in administration, I don't see that happening. And so, I think Congress is really best suited to address something like, how do you have interstate commerce, reciprocity between similar programs, and the like? What is an appropriate safety regime for cannabis? These things are all going to need to be figured out federally, so it's uniform.”

If cannabis is officially rescheduled, then when will Internal Revenue Code, Section 280E no longer apply?

“From everybody I've talked to, including the top 280E folks … prior to the rescheduling coming into effect, 280E will continue to apply,” Zagzebski said. “And so folks are going to have to call their accountants. Because what you have to do and be very careful to do is document appropriately that shift. The moment cannabis is rescheduled, 280E no longer applies, but the moment prior to that, it still will apply. And so the accountants are going to have to figure out how to allocate expenses.

“The reason that I say that is because 280E is a statute. It's the law. I don’t think the IRS has the discretion to depart from it, and 280E is not being repealed. It's simply that cannabis is being rescheduled from one to three, and by the terms of 280E, 280E will no longer apply once that occurs. I don't think that the IRS has the discretion to say, 'Oh, we're going to let you go for the whole year because marijuana was rescheduled on November 1,’ let's say. And so what that means for taxpayers is that they're basically going to have two different regimes, two different frameworks.”

What will be the biggest impact for companies in terms of deductions?

“All of a sudden, they have the ability to start planning like other folks,” Zagzebski said. “They can start to hire accounting consultants that do accelerated depreciation analysis on their hardware in their indoor grow, for example. All their expenses are now deductible as if they were a non-cannabis business. And so now they can do the more sophisticated tax planning that ordinary businesses do right now.

“Make sure the CFO has the chops to implement it because they're going to have to be looking at the whole entirety of the business deductions that they're allowed to take. They can start to deduct things like their payroll, their salaries. The most significant is just the basics. Payroll is one of the biggest things you can deduct. [With 280E] they had to maximize their cost of goods sold. Now they don't have to do that, and in fact, they can think much more granularly about what expenses they can take and when.”

Will rescheduling change rules around interstate commerce?

“The state programs were all designed to be seed-to-sale in state. They favor largely in-state folks, and it's just a completely isolated silo in most states,” Zagzebski said. “But from a constitutional perspective, it's the federal government that has the right to regulate commerce among the states. And the Dormant Commerce Clause prohibits states from discriminating against out-of-state producers. And so the question would be, does relaxing federal regulation start to provide an opening for people to challenge some of the rigidity in the state programs when it comes to things like interstate commerce or discriminating against out-of-state residents? That's still an open question, but I don't think simply moving from one to three has a major impact on any of state programs.

“I don't think that's a big issue in 2024 because I think in 2024, it's all about 280E. But then going forward, as regulations start to happen or interpretive memos come out, whatever form they take, then I think we start to see more of these questions being asked.”

What does rescheduling mean from a mergers and acquisitions and a capital availability perspective, and when do you expect to see this take shape?

“I think it's the best news the capital markets have seen in a while,” Zagzebski said. “You certainly saw that the stocks reacted very favorably to the news. I think that this provides the first thesis that we've seen in years for new capital to come into the industry. I think you are likely to see people put together war chests in the next few months so that they can buy assets from folks that are still distressed, folks that owe a bunch of money to lenders and even owe a bunch of back 280E taxes and folks with fresh capital. People with fresh capital that buy assets free and clear of liens that they can start operating later in the year in a non-280E environment, I think there will be a lot of those folks who come out of the woodwork who start clean and fresh without this 280E regime.

“I think we're going to see a lot of mid-market M&A. I think we're going to see a lot of asset transactions. We're going to see a lot of people trying to negotiate with creditors. 280E doesn't solve all of the fundamental problems, because, in a lot of markets, the issue is simply supply and demand.”

“There's definitely going to continue to be consolidation as there has been in the industry, but establishing brand and reputation across the country as opposed to within individual markets will be needed once interstate commerce is permitted,” Havens said.

What can businesses do now while they wait for the final rulemaking process to play out?

“The immediate thing is to pay very close attention to DEA rulemaking,” Havens said. “And it's not just that, but it's actively participating in the rulemaking process. [Don’t] assume someone else is going to advance the arguments that you want to advance. There are a number of different advocacy groups within the cannabis space. Now is the time for cohesiveness and speaking with one voice.”