[[{“value”:”
The year 2024 was a record-breaking year for legal marijuana sales—but recent activity from the federal government suggests that 2025 may look a little different. Weeks after the U.S. Drug Enforcement Administration (DEA) signaled that it might be putting the brakes on efforts to reschedule cannabis, two Republican U.S. senators introduced a bill that would continue to ban tax deductions for cannabis businesses.
Rescheduling Cannabis
While still prohibited by federal law—possession can lead to fines and jail time—most states and the District of Columbia have legalized cannabis for medical or recreational use (or both). Under federal law, however, it’s classed as a Schedule I drug—on par with heroin and LSD—which means that it is not legal in any form. It is against federal law to grow, sell, or use cannabis for any purpose, including medical reasons.
A Biden administration proposal would have moved cannabis from its current classification as a Schedule I drug to a Schedule III drug alongside ketamine and some anabolic steroids. This move would have been the most significant change to cannabis in more than 50 years.
In May of 2024, the DEA published its proposed rule related to rescheduling cannabis. As is required by law, the matter was open to public comment. More than 43,000 comments were submitted, with nine in ten in favor of reform.
The next step in the process was to hold hearings, which were scheduled for January 2025. After months of procedural back and forth, DEA Administrative Law Judge John Mulrooney canceled the hearing. It is unclear when the hearing might be rescheduled. That means that rescheduling is currently on hold.
(You can read the order here.)
What Rescheduling Wouldn’t Do
If the proposal were to move forward (a move that appears less likely by the day), it’s important to note that rescheduling cannabis to a Schedule III drug is not the same as decriminalizing or legalizing cannabis. The manufacture, distribution, dispensing, and possession of marijuana would remain illegal.
The move also wouldn’t fix the cannabis industry’s banking problem. Because the industry is illegal, federal law prevents banks from assisting cannabis businesses. As a result, it’s a cash-only business, which, among other things, makes regulating—and taxing it—difficult.
Taxation
Currently, cannabis sellers must report their income even though the sale remains criminal under federal law. Interestingly, it was the taxation of cannabis in the 1930s that led to criminalization in the first place. In the early part of the 20th century, during Prohibition, booze was illegal, but cannabis was not.
Under the 1937 Marihuana Tax Act (yes, with an “h”), cannabis was legal—and taxed. There was a two-part tax on sales, one which functioned like a sales tax and another more akin to an occupational tax for licensed dealers. Failure to comply resulted in severe consequences.
In 1969, Timothy Leary challenged his arrest for possession of cannabis under the Act. Leary v. United States made it to the Supreme Court, where part of the 1937 Act was invalidated as a violation of the Fifth Amendment against self-incrimination. The result was a new law, the Controlled Substances Act, passed in 1970, which criminalized the possession or sale of cannabis for federal purposes—it has remained so to this day.
IRS Weighs In
The IRS was fairly quiet about the taxation of cannabis until 2011, when it made clear that it would disallow expenses for medical dispensaries. The justification? Section 280E of the Tax Code which states: No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedules I and II of the Controlled Substances Act, or CSA) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.
In 2015, the IRS indicated it might be softening. As the popularity of cannabis increased, IRS Memorandum 201504011 took another look at the tax deduction question. The memo didn’t reverse course on the issue of the deductions, but it did suggest that, by looking at section 263, careful consideration of the characterization of certain activities might result in legitimate reductions in tax.
Today, for federal tax purposes, cannabis businesses are generally only deductible for the cost of goods sold (COGS). Traditional business costs, such as employee payroll, marketing, and selling expenses, remain non-deductible. Depending on the state, this can result in an effective tax rate between 40% and 70% for cannabis-based businesses.
In 2021, the IRS took steps to resolve confusion—and lost tax dollars—by addressing tax implications for the cannabis industry. Today, the IRS maintains a cannabis industry page on its website focused on section 280E, income reporting, and cash payment options.
The IRS has also clarified that the treatment of cannabis under section 280E applies even if businesses operate in states that have legalized sales. The agency’s stance related to COGS also hasn’t changed, meaning it remains deductible.
No Deductions for Marijuana Businesses Act
That brings us to the “No Deductions for Marijuana Business Act.” While rescheduling would not make cannabis legal, it would allow cannabis businesses to claim tax deductions for business expenses—section 280E only disallows deductions related to “trafficking in controlled substances (within the meaning of Schedules I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”
Rescheduling cannabis to Schedule III should mean that business expenses would be allowed. S.471, introduced on February 6 by Senators Pete Ricketts (R-Nebraska) and James Lankford (R-Oklahoma), would prevent cannabis businesses from deducting business expenses on their federal tax returns.
Specifically, the bill calls out cannabis by name—not by Schedule—as ineligible for deduction.
In a statement posted on his website, Ricketts said, “The federal government should not be subsidizing an industry that profits from addiction and undermines public safety. “This bill ensures that marijuana businesses do not receive tax breaks while they continue to violate federal law.”
Results
Darren Gleeman, Managing Partner of MBO Ventures, the cannabis industry’s only investment bank dedicated to Employee Stock Ownership Plans (ESOPs), called the bill “a direct attack on the economic viability of the cannabis industry.”
“This would,” Gleeman continued, “eliminate the main financial relief that rescheduling was expected to bring. This move could stifle investment, innovation, and job growth, while giving illicit markets an unintended advantage. Instead of creating a sustainable, tax-paying industry, this bill keeps cannabis businesses in financial handcuffs.”
Noting that the partisan margins in Congress are slim—bills need every vote to pass—Gleeman expressed skepticism that the bill would pass. There are, he believes, three or four Republican Senators who “won’t go for” and, as a result, he doesn’t think the bill will go anywhere.
He also believes that the move to reschedule cannabis is dead—at least for the next four years. He notes that most government officials in leadership positions appointed by President Donald Trump are anti-cannabis. The result, Gleeman believes, is that cannabis businesses can’t count on any real change in Washington.
If that happens, it would be a reversal from Trump’s position before the election, when he appeared to support cannabis reform. In a Truth Social post from September, Trump declared, “As I have previously stated, I believe it is time to end needless arrests and incarcerations of adults for small amounts of marijuana for personal use. We must also implement smart regulations, while providing access for adults, to safe, tested product.”
He continued, “As President, we will continue to focus on research to unlock the medical uses of marijuana to a Schedule 3 drug, and work with Congress to pass common sense laws, including safe banking for state-authorized companies, and supporting states rights to pass marijuana laws, like in Florida, that work so well for their citizens.”
However, Gleeman isn’t optimistic. He expects the cannabis industry to maintain the status quo, including a grim tax picture. “The tax is insane,” he says, referring to the margins. “People are frustrated.”
The tax picture isn’t just a problem for businesses—it’s also a problem for tax authorities. Currently, some cannabis businesses can’t pay their tax bills, which results in lower collections. And there’s a bigger issue brewing at the state level—state authorities are increasingly relying on revenues from cannabis to offset spending or tax reductions. If those revenues don’t materialize, states could be left with big holes to fill (states collected nearly $3 billion in marijuana revenues in 2022, and many hope that number will continue to grow).
Gleeman thinks that could happen, but he suggests there’s a bigger problem with state reliance on cannabis revenue: it’s based on the wrong numbers. Tax authorities, he says, tout numbers associated with illegal cannabis sales when making projections. They have failed to recognize, he explains, that the price of cannabis would go down as it becomes more legally and readily available. That’s already bearing out—there’s been a steady decline in the price of cannabis, and that’s expected to continue. According to the University of Colorado (Boulder), prices are falling in Colorado, the first state to sell regulated recreational marijuana. The average price per gram of recreational marijuana flower was $4.83 in 2021, $3.84 in 2022, and $3.43 in 2023—as are gross revenues. According to the Colorado Department of Revenue, 2023 sales were $1.3 billion as of the end of October, trailing 2022’s $1.77 billion in sales and 2021’s $2.2 billion in sales.
Gleeman believes the industry could be in real trouble if changes aren’t made. He thinks he has a solution—an ESOP, or Employee Stock Ownership Plan. In simple terms, an ESOP is an employee benefit plan that gives workers shares of stock in a company. It’s often used as a retirement benefit or incentive plan. The National Center for Employee Ownership (NCEO) estimates (using 2022 data, the most recent available) that there are 6,548 ESOPs at 6,358 companies, covering 14.9 million participants and holding over $1.8 trillion in assets.
The benefits for non-cannabis companies are straightforward. As with most benefit plans, contributions are tax-deductible—employees pay no tax on the contributions until they receive the stock. When the stock ends up in the hands of the employees, usually at retirement, they typically cash out by selling it on the market (as you would for a public company) or back to the company. If the company meets certain criteria, the owners can defer taxation on their capital.
But here’s what makes it appealing to cannabis companies, explains Gleeman: earnings inside certain ESOPs (typically, ESOP-owned S corporations) are not taxable. That means that those external factors that companies can’t control—the rescheduling of cannabis and section 280E would not stand in the way of generating higher margins. He sees it as a win-win situation.
Other Approaches
Some cannabis companies have taken more aggressive approaches by ignoring section 280E. In 2024, some taxpayers opted to file amended returns and seek a refund of taxes paid related to section 280E. According to the IRS, the grounds for filing such claims vary, but these claims are not valid since “[t]he law with respect to the schedule or classification of marijuana has not changed.” That means, the agency says, that taxpayers seeking a refund of taxes tied to section 280E are not entitled to a refund or payment.
The IRS has also clarified that the treatment of cannabis under section 280E applies even if businesses operate in states that have legalized sales. The agency’s stance related to COGS also hasn’t changed, meaning it remains deductible.
Other companies have transitioned to selling more hemp. As a result of the 2018 Farm Bill, hemp is defined as “the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.” Hemp was also removed from the CSA, meaning that it’s not a Schedule I drug. That means it’s not subject to section 280E and can be taxed like any other business.
No matter the tack, many cannabis businesses are rethinking how they do business. That could result in some shakeups in the industry. Whether and how the Trump administration’s stance on rescheduling changes will clearly have an impact on cannabis going forward.
“}]] While still prohibited by federal law, most states and D.C. have legalized cannabis for medical or recreational use (or both). A move to reschedule the drug is on hold. Read More
