The Potential Rescheduling of Cannabis in the United States and Its Impact on R&D Tax Credits for the Cannabis Industry
The landscape of the cannabis industry in the United States is evolving rapidly, with potential federal rescheduling of cannabis on the horizon. Currently classified as a Schedule I controlled substance under the Controlled Substances Act (CSA), cannabis is subject to stringent regulations that have limited the industry's ability to access many benefits available to other sectors, including the federal Research and Development (R&D) Tax Credit under IRC Section 41.
Important Developments: On December 2, 2024, a preliminary hearing was conducted at the Drug Enforcement Administration as part of ongoing hearing proceedings in connection with the potential rescheduling of marijuana. See the US Department of Justice’s hearing ruling published on December 4, 2024 (here). This comes after a notice of proposed rulemaking (NPRM) issued earlier in the year by the Department of Justice (here).
Next Steps: The hearings will commence again in January and are scheduled to go through early March 2025. Note: the next hearing that was originally scheduled to begin this week (Tuesday, January 21, 2025), regarding the proposed rescheduling of marijuana has been postponed pending resolution of an appeal filed by a party in the proceedings. So it is TBD when that will be scheduled for, but the Government is the party slated to present in that session.
While the outcome and timeline are unknown, if cannabis were to be rescheduled, it could open new opportunities for cannabis companies, particularly in the realm of R&D tax credits.
Current Status of Cannabis and Its Implications
Cannabis is currently classified as a Schedule I substance, indicating that it is considered to have a high potential for abuse, no accepted medical use, and a lack of accepted safety for use under medical supervision. This classification places significant legal and regulatory burdens on the cannabis industry, including:
Limited Banking and Financial Services: Many financial institutions are hesitant to work with cannabis businesses due to federal restrictions.
Taxation Challenges: Cannabis companies are subject to IRC Section 280E, which prohibits the deduction of ordinary business expenses, severely impacting their profitability.
Ineligibility for Federal R&D Tax Credits: Due to its Schedule I status, expenses related to cannabis research do not qualify for the R&D Tax Credit under IRC Section 41.
Potential Rescheduling of Cannabis
The potential rescheduling of cannabis would involve reclassifying it to a lower schedule under the CSA, which would acknowledge its medical uses and reduce some of the federal restrictions currently in place. This shift could have profound implications for the cannabis industry, including:
Eligibility for R&D Tax Credits: Rescheduling cannabis would allow companies engaged in cannabis research and development to qualify for the R&D Tax Credit for the first time in history. This credit provides a financial incentive for companies to invest in innovative research by allowing them to claim a percentage of their R&D expenses as a tax credit.
Increased Investment in Innovation: With access to R&D tax credits, cannabis companies would have a stronger financial incentive to invest in developing new products, improving cultivation methods, and enhancing extraction techniques. This could lead to significant advancements in the industry and promote further scientific research.
Alignment with Other Industries: The rescheduling of cannabis would help level the playing field, allowing cannabis companies to compete more fairly with other industries that already benefit from federal tax incentives for R&D.
Types of Qualifying R&D Activities for Cannabis Companies
If cannabis is rescheduled and becomes eligible for R&D tax credits, various activities conducted by cannabis companies could qualify, including:
Cultivation Techniques: Research into developing more efficient, sustainable, or innovative cultivation methods, such as optimizing light cycles, soil nutrients, or irrigation systems, could qualify as R&D activities.
Product Development: Creating new cannabis-based products, such as edibles, topicals, or pharmaceuticals, involving experimentation and testing could be considered qualifying R&D.
Extraction and Processing: Improving extraction methods to increase the purity or potency of cannabinoids, or developing new processing techniques to create more effective delivery systems, would be eligible.
Strain Development: Breeding new cannabis strains with unique properties, such as higher CBD content or specific terpene profiles, involves substantial research and experimentation.
Biotechnology: Engaging in genetic engineering or other advanced biotechnological methods to enhance plant characteristics or disease resistance could qualify for R&D tax credits.
Quality Assurance and Testing: Developing new protocols for quality control and product testing to ensure consistency, safety, and efficacy of cannabis products can be included as R&D activities.
Automation and Technology Integration: Innovating in the automation of cannabis cultivation or processing, as well as integrating advanced technologies like AI for monitoring and optimizing production, would also be eligible.
Benefits of R&D Tax Credits for Cannabis Companies
If eligible for R&D tax credits, cannabis companies could benefit in several ways:
Reduced Tax Liability: The R&D tax credit can significantly reduce a company’s federal tax liability, freeing up resources to reinvest in further research and development.
Enhanced Competitiveness: Access to additional funding through tax credits can enable cannabis companies to innovate more rapidly, staying ahead in a competitive market.
Encouragement of Scientific Research: By offsetting some of the costs associated with R&D, tax credits could encourage more scientific studies on cannabis, leading to new discoveries and applications.
Conclusion
The potential rescheduling of cannabis in the United States represents a landmark opportunity for the cannabis industry to access federal R&D tax credits under IRC Section 41. This change could stimulate significant growth and innovation within the industry, benefiting not only cannabis companies but also consumers and the broader economy through advancements in cannabis-related products and technologies.
Understanding the types of activities that could qualify for R&D tax credits can help cannabis companies prepare to take full advantage of these incentives if rescheduling occurs. As discussions around cannabis rescheduling continue, stakeholders in the cannabis industry should prepare to leverage new opportunities that may arise, including the potential to claim R&D tax credits for the first time.
Better Credits is here to help. If you would like to better understand your eligibility so you can hit the ground running in the event the rescheduling is successful, reach us at hey@bettercredits.com or schedule a scoping call (here).
