High Hopes: How Cannabis Schedule 3 Reclassification Impacts New York’s Cannabis Industry
Introduction
On April 30, 2024, the U.S. Drug Enforcement Administration (DEA) made a significant announcement proposing the reclassification of cannabis from Schedule I to Schedule III under the Controlled Substances Act. (1)
This change is poised to reshape the cannabis industry, especially in New York, where both medical and adult-use cannabis markets are already established. Moving cannabis to Schedule III acknowledges its accepted medical uses and lower potential for abuse compared to Schedule I drugs, which are considered to have no accepted medical use and a high potential for abuse.
For New York’s cannabis businesses, this reclassification could reduce regulatory burdens and financial challenges, potentially enhancing profitability and operational efficiency across the state. This shift marks a critical development in the ongoing transformation of cannabis regulation in the United States, reflecting changing perceptions and increasing acceptance of cannabis’ benefits.
The Controlled Substances Act (CSA)
The Controlled Substances Act (CSA), enacted in 1970, is the statute prescribing federal U.S. drug policy under which the manufacture, importation, possession, use, and distribution of certain substances is regulated. (2)
The CSA categorizes drugs into five schedules (Schedule I to V) based on their potential for abuse, status in international treaties, and any medical benefits they might offer.
Cannabis as a Schedule I Drug
Originally, cannabis was classified as a Schedule I drug, a category reserved for substances with a high potential for abuse, no currently accepted medical use in treatment in the United States, and a lack of accepted safety for use under medical supervision. Other drugs in this category include heroin, LSD, and ecstasy.
Implications of Schedule I Status
Being under Schedule I has significant implications for cannabis. It restricts scientific research and development because researchers need a special license to study it, complicating efforts to explore its full medical potential. Additionally, businesses dealing with cannabis face high taxes and banking challenges, as federal law restricts their access to financial services, treating their activities akin to drug trafficking.
Towards Reclassification
Over the years, the Department of Health and Human Services (HHS) and the DEA have reviewed the status of cannabis, influenced by emerging research and public sentiment favoring its medicinal and therapeutic potential.
These reviews culminated in the recent proposal to reclassify cannabis to Schedule III, recognizing its accepted medical uses and lower potential for abuse compared to Schedule I drugs. This reclassification could significantly ease research restrictions and improve the operational landscape for cannabis businesses in New York and beyond.
Implications of Schedule III Reclassification for New York.
Let's delve into the specific implications of moving cannabis to Schedule III and how this shift impacts New York's cannabis industry in areas like taxation and financial services.
Federal Tax Code Changes
The reclassification of cannabis to Schedule III would have significant implications for the cannabis industry in New York, particularly in terms of taxation. Currently, under Internal Revenue Code (IRC) Section 280E, businesses dealing with Schedule I or II controlled substances cannot deduct ordinary business expenses. (3)
After the reclassification, these businesses can deduct expenses like rent, wages, and other operational costs, similarly to other industries. This change could substantially decrease the tax burden on cannabis businesses, increasing their profitability and sustainability.
Continued Constraints Despite Reclassification
While reclassification to Schedule III reduces some regulatory barriers, it does not fully resolve banking and financial service issues. Cannabis will still be considered a controlled substance under federal law, causing hesitancy among financial institutions to fully engage with cannabis businesses due to lingering regulatory and compliance risks.
However, the reclassification might encourage more banks to consider offering services to the cannabis industry, as the lower scheduling could be perceived as lower risk compared to Schedule I status. This could improve access to banking services like business accounts, loans, and credit facilities, albeit cautiously.
Potential for Future Enhancements
The shift to Schedule III could also pave the way for future legislative changes that further integrate the cannabis industry into the financial system. There's ongoing discussion about laws such as the Secure and Fair Enforcement (SAFE) Banking Act, which aims to protect financial institutions that service cannabis businesses. (4)
As federal attitudes toward cannabis continue to evolve, the potential for more robust financial services grows, which would support the industry's expansion and integration into mainstream business practices.
Taxation and Compliance Adjustments for Current License Holders
Tax Relief for Cultivators and Dispensaries
With the reclassification of cannabis to Schedule III, the 220 conditional cultivators and 117 retail dispensaries in New York, as recognized by the Office of Cannabis Management (OCM), stand to benefit significantly from changes in federal taxation. (5) (6)
Navigating Compliance Changes
Despite the tax benefits, compliance complexities remain. These businesses must adjust to new regulatory frameworks that may evolve as federal and state laws converge on the new scheduling status.
They will need to stay informed and possibly overhaul their compliance strategies to align with both existing state regulations and newly relaxed federal standards. This involves continual monitoring of guidelines from both the OCM and federal agencies to ensure they do not inadvertently breach compliance amid the regulatory transitions.
Opportunities for New Entrants
The reclassification of cannabis to Schedule III opens up significant opportunities for new entrants in the New York cannabis market, particularly under the Social and Economic Equity (SEE) initiatives. (7)
These initiatives are designed to support individuals from communities that have been disproportionately affected by previous cannabis laws. With the shift to Schedule III, new entrants might find a more favorable business environment as the reduced federal restrictions could lower the entry barriers, making it easier to start and operate cannabis businesses.
Challenges for New Entrants
Despite the opportunities, new entrants face challenges, primarily related to navigating complex compliance and regulatory frameworks. Even with federal reclassification, the state of New York maintains its own set of cannabis laws and regulations that must be adhered to.
New businesses must ensure they are compliant with both state and federal regulations, which can be a daunting task without adequate legal and professional support.
Furthermore, while the market becomes more accessible, new entrants will face stiff competition from established businesses that are already familiar with the market dynamics. The competitive landscape can be challenging for newcomers who need to establish their brand and gain market share in a space where many businesses are already capitalizing on the new regulatory changes.
Navigating Regulatory and Compliance Hurdles
New York businesses in the cannabis industry must navigate a complex landscape of regulations that now includes both revised federal status and existing state laws.
The move of cannabis to Schedule III federally offers some relief from stringent controls but does not override state regulations that govern the licensing, production, distribution, and sale of cannabis. Businesses must ensure compliance with both sets of regulations, which can involve significant legal and administrative efforts.
Financial institutions need to operate under strict regulatory frameworks that necessitate adherence to protocols such as Know Your Customer (KYC) and Anti-Money Laundering (AML) standards. (3) They are required to identify and report any suspicious activities to the Financial Crimes Enforcement Network (FinCEN). Additionally, these institutions must also report cases of potential fraud, tax evasion, and illegal drug trafficking to the appropriate authorities.
Understanding State-Federal Synergies and Conflicts
The reclassification of cannabis at the federal level introduces potential synergies and conflicts with New York state laws.
While federal reclassification reduces the burden on businesses in terms of taxation and banking, state laws in New York may still impose strict rules on how cannabis businesses operate, particularly concerning health and safety standards, local zoning laws, and marketing practices. Businesses must stay informed and adaptable to align with both federal easing and state controls.
Managing Compliance Amidst Regulatory Changes
New York businesses must continuously monitor regulatory updates from both the state and federal governments to ensure they are operating within the law. This includes understanding how federal changes affect state-level compliance requirements and vice versa. Regular consultations with legal experts in cannabis law are advisable to navigate these complexities effectively.
Enhancing Opportunities for Clinical Research
The potential reclassification of cannabis could significantly benefit the medical and scientific research communities. The current classification of cannabis as a Schedule I substance has imposed substantial barriers to research.
These include restrictions such as the requirement for a single approved domestic source of cannabis, complex registration protocols for Schedule I substances, and the classification of even non-psychoactive components like CBD under Schedule I.
Researchers are also faced with navigating a complex federal regulatory and approval landscape that involves multiple agencies such as the National Institute on Drug Abuse (NIDA), the U.S. Food and Drug Administration (FDA), and the Drug Enforcement Administration (DEA). Rescheduling cannabis would alleviate many of these challenges, making it easier to conduct comprehensive and meaningful research into its effects and potential medical benefits.
Key Stages in Reclassifying Cannabis
The process for the DEA to reclassify cannabis as a Schedule III substance involves several steps and can be quite time-consuming. (8)
After receiving a recommendation from the Department of Health and Human Services (HHS), the DEA undertakes its own review, which includes a detailed analysis based on eight factors specified in the Controlled Substances Act (CSA).
These factors include the drug's potential for abuse, its known scientific evidence, and its history and current pattern of abuse among others.
Once the DEA completes its review, it will propose a rule to reclassify cannabis, which is then published in the Federal Register. This publication initiates a public comment period, typically lasting 60 days, allowing stakeholders to provide feedback. Following the comment period, the DEA may also hold a formal administrative hearing based on the requests from interested parties.
The entire process, from the HHS recommendation to the DEA's final rule, often extends over several months. In some cases, it has been noted that the process could take anywhere from three to six months after the HHS delivers its recommendation, though it can vary based on the complexity of the issue and the volume of public interaction.
Conclusion
The shift from Schedule I alleviates many operational hurdles, notably in taxation and banking. Businesses can now expect significant tax relief as they become eligible to deduct common business expenses, enhancing profitability. Moreover, although complete financial integration remains elusive, improved banking access could spur further growth and stability within the industry.
However, aligning with both state and federal regulations continues to be a complex task. New York's stringent state laws may still pose significant operational challenges, even as federal barriers lessen. Businesses must navigate these dual layers of regulation adeptly, ensuring compliance while optimizing the new advantages available under Schedule III.
Looking forward, cannabis businesses in New York might need to consider strategic advocacy for more harmonized regulations that align state and federal laws. This would not only reduce compliance complexity but also maximize the industry’s potential for growth. Advocacy efforts could focus on promoting clarity and uniformity in how cannabis is treated across regulatory environments.
The evolution of cannabis laws is an ongoing process, and staying informed and engaged with regulatory developments will be crucial for businesses aiming to thrive in this dynamic market. We invite you to comment below with your thoughts and insights on how these changes might shape the future of the cannabis industry in New York.
References
DEA Aims to Reclassify Marijuana as Less Dangerous Drug. Drug Topics. Published May 1, 2024. https://www.drugtopics.com/view/dea-aims-to-reclassify-marijuana-as-less-dangerous-drug
Ortiz NR, Preuss CV. Controlled Substance Act. PubMed. Published 2023. https://pubmed.ncbi.nlm.nih.gov/34662058
DEA’s Plan to Reschedule Cannabis: Implications and Insights. McCarter & English, LLP. Published May 3, 2024. https://www.mccarter.com/insights/deas-plan-to-reschedule-cannabis-implications-and-insights/
What reclassifying marijuana means for Americans. PBS NewsHour. Published May 1, 2024. https://www.pbs.org/newshour/health/what-reclassifying-marijuana-means-for-americans
Adult Use Conditional Cultivator Licenses. https://cannabis.ny.gov/system/files/documents/2023/10/aucc-licensees.pdf
Dispensary Location Verification. Office of Cannabis Management. https://cannabis.ny.gov/dispensary-location-verification
Social and Economic Equity. Office of Cannabis Management. https://cannabis.ny.gov/social-and-economic-equity
Jaeger K. DEA Officials Discuss Marijuana Scheduling Timeline, Seeking To “Correct Misperceptions” That Decisions Are Made In A “Shroud Of Secrecy.” Marijuana Moment. Published March 28, 2024. https://www.marijuanamoment.net/dea-officials-discuss-marijuana-scheduling-timeline-seeking-to-correct-misperceptions-that-decisions-are-made-in-a-shroud-of-secrecy/
