Potential Impacts of Rescheduling on the Cannabis Industry in Massachusetts
by Michael P. Ross
When April 20, 2024, or “4/20,” the unofficial holiday within the cannabis world, came and went without movement on the long anticipated federal rescheduling of cannabis from a Schedule I to a Schedule III substance, some industry watchers were skeptical that the reclassification would happen. Just ten days later, however, news broke that the federal government was in fact proceeding with the plan. For those attorneys who practice within this space, the consequences of this historic shift, particularly within the context of other steps towards the legitimization of the cannabis industry both at a federal level and in Massachusetts, are very significant.
The brief history of rescheduling starts with the Controlled Substances Act, passed in 1970, which created five schedules or classifications of various substances, and placed cannabis on Schedule I, along with heroin, LSD, and other drugs with “no currently accepted medical use treatment” value. In October 2022, the Biden administration announced its intention to reschedule cannabis to Schedule III, a classification of drugs that have an “accepted medical use in treatment” and are available with a prescription.
To be clear, reclassifying cannabis does not legalize recreational cannabis nationwide, but instead places cannabis with other Schedule III drugs, including ketamine, anabolic steroids, and some acetaminophen-codeine combinations. The immediate effects, particularly relevant to the legal community, will be the resulting changes for cannabis operators. The most significant issue will be the end of the application of IRS Rule 280E. As a Schedule I drug, Rule 280E limits cannabis companies from writing-off legitimate business expenses as other businesses are entitled to do. With the exception of cost of goods sold (the cannabis itself), all other expenses—rent, employees, operational costs—were not allowed to be counted as an expense, and therefore, were essentially counted as revenue, and taxed accordingly. Moving cannabis from Schedule I to Schedule III will end this requirement, and essentially bring overnight liquidity to these businesses.
Notably, prior to the federal rescheduling announcement, some businesses had already challenged 280E’s legality. Earlier this year, the cannabis companies Trulieve and TerrAscend collected refunds of over $150 million when they stopped paying 280E taxes. Other companies are following their lead. Undoubtedly, the lawsuit against the Department of Justice on behalf of four Massachusetts state-licensed companies, alleging that the Controlled Substance Act is unconstitutional, at least partially motivated these businesses in their decision to cease making payments.
In addition to 280E no longer applying, there are other benefits that are expected from rescheduling, including removing barriers to obtaining federal trademarks. Due to cannabis’ prior illegal status under federal law, federal trademarking had been difficult for cannabis companies and their products. Once the reclassification is official, the U.S. Patent and Trademark Office (“USPTO”) should be open to these brands. Rescheduling should also mitigate the attempted workarounds currently used by some companies such as registering trademarks for certain hemp products under the federally legal Farm Bill for products that contain less than 0.3 percent THC (and are not listed as a Schedule I substance). Many of these products share the same marks and brand names as their cannabis counterparts. It is worth noting that the current hemp market has created havoc within the industry, often forming new synthetically manipulated and intoxicating products that are illegal, and claiming regulatory ambiguity within the federal and state laws, even when, as here in Massachusetts, the regulations clearly prohibit foods containing CBD or any THC or synthetically derived THC products.
Another key area likely to change is bankruptcy proceedings. Here again, legal restructuring options such as bankruptcy, were not available to federally non-legal companies. While there are state law protections available for state legal cannabis entities, federal protection is not. Other alternatives to bankruptcy would be contractual arrangements, or receiverships – but here too, with receiverships, given the regulatory nature of cannabis at the state level, receivers must be licensed by the state authority to step into this role. Once rescheduling is complete, cannabis companies should have access to federal bankruptcy protection.
As referenced, rescheduling is not the only potential major regulatory change for the cannabis industry. The SAFER Banking Act, currently making its way through Congress, would open up banking and other business services to state-legal operators who are currently not able to participate in these markets. While there are some state-chartered, credit-union facilities, and smaller banks participating in the industry, most of the larger banks are not. SAFER would allow nearly all financial institutions and services to participate in the industry, which would lower associated costs, and allow cannabis companies to keep more of their money.
At the state level, we are already seeing reforms that are helpful to the cannabis industry. In Massachusetts, we have witnessed the reform of the Host Community Agreement process, the statutorily required agreement between an operator and the host community that establishes the mutual responsibilities between the parties. The “reform” which came as a result of the passing of the Acts of 2022, Chapter 180, “An Act Relative to Equity in Cannabis Industry,” as well as the regulatory regime promulgated by the Cannabis Control Commission, puts guardrails on just how far a municipality can go in extracting fees from an operator. While the statutory revisions only go so far, cannabis operators in Massachusetts also scored a win through a settlement agreement in a lawsuit that was pending before the Superior Court. In 2022, Caroline’s Cannabis, LLC filed suit against the Town of Uxbridge, seeking a refund for fees that it paid to the town that were not “reasonably related” to its operation as a marijuana retailer. Uxbridge agreed to pay the operator $1.2 million, opening the door for other operators to follow suit (both figuratively and literally).
This industry moves quickly, and a nimble practitioner will need to keep up to speed with these changes in order to serve as an effective advocate for clients.
Michael P. Ross is a partner in the Real Estate Group and co-chair of the Cannabis Practice Group at Prince Lobel Tye LLP.
