Rescheduling could be a big problem for the marijuana industry

Early this month, the Drug Enforcement Administration announced that it would make a decision on whether to reclassify marijuana. Under the Controlled Substance Act, the federal government considers marijuana a Schedule I narcotic, meaning that it has high potential for abuse and no medical benefits, a position at odds with the 24 states that have legalized medical marijuana and the millions of casual users currently enjoying the occasional smoke. There's little dispute that the current classification of marijuana is absurd — other Schedule I drugs include heroin, LSD and MDMA; both cocaine and methamphetamine are considered less onerous Schedule II drugs. But there is much debate about what rescheduling might mean for the nascent legal pot industry.

Everyone agrees, that rescheduling marijuana would make it easier for scientists to research the plant. It would also vindicate the widely held belief that marijuana has important medicinal properties. And for the businesses generating over $5 billion worth of revenue on marijuana products each year, rescheduling would mean a major step towards finally legitimizing the industry.

But there is also cause for some concerns. The DEA has rejected petitions to reschedule marijuana three times. In each instance, the agency took years to make the decision. That kind of uncertainty is toxic for young businesses. In addition, rescheduling marijuana could unleash new federal oversight that would make life even more difficult for companies that already operate at the whim of the White House. The Obama administration has allowed the industry to operate in states where pot is legal, but the next administration could take a different approach.

Hilary Bricken, a cannabis business lawyer with the Seattle firm Harris Moure, says she's not optimistic that the DEA will reschedule. "It's so speculative as to what the DEA will do and what will happen," she says. But she does worry that rescheduling could cause a crackdown on state legal businesses, or set the stage for greater federal involvement in marijuana regulation.

If the federal government determines that medical marijuana must be subjected to FDA approval, companies would have to enter a process that can take years to complete and cost more than $1 billion per product. Few, if any, cannabis companies in the U.S. have the resources for that, which might open the door for Big Pharma to muscle in and take over the business. "They could put every medical provider in the country out of business in a matter of months," says Dean Heizer, chief legal strategist at LivWell, one of Colorado's largest marijuana companies.

At the same time, Constance Finley, CEO of Richmond, Calif.-based Constance Therapeutics, believes rescheduling will help her company achieve medical credibility. Constance Therapeutics plans to conduct a trial of its marijuana products on former NFL players to determine if they relieve chronic pain and brain trauma, which players commonly treat with opioids. She thinks the introduction of new rules, even the FDA's rigorous approval process, would enable it to differentiate itself from competitors. "I'm no longer afraid we'll be washed out," she says.

Rescheduling could bring another important benefit for pot businesses. They are eager to rid themselves of a burdensome tax provision — known as 280E — that prohibits businesses that deal in schedule I and II controlled substances from deducting many of their business expenses. As a result of 280E, state-legal marijuana companies can have an effective federal tax rate of more than 60 percent. "For the most part, businesses are disregarding 280E or creating legal workarounds that may or may not withstand scrutiny of the IRS," says Aaron Herzberg, a partner at the southern California company CalCann.

The tax restriction originated in 1982, after a Minnesota dealer named Jeffrey Edmondson tried to deduct business expenses on his taxes. (Ill-gotten lucre is taxable — that's how they got Al Capone.) Edmondson sued in tax court and partially won his case. In response, incensed members of Congress swiftly enacted the federal restriction. State-legal businesses have since made its repeal a top priority. Rescheduling marijuana to III or lower would take care of the issue, but a change to Schedule II would not. The DEA said in its letter to Congress that its decision will focus on medical marijuana research, suggesting that reducing marijuana business taxes is not a part of the agency's plan.

Most marijuana companies and advocates ultimately want to see the drug descheduled, like alcohol and tobacco. (In this scenario, it's widely believed that a pharmaceutical marijuana industry would splinter off and be regulated by the FDA like other prescription drugs.) "Rescheduling marijuana could be regarded as a step in the right direction, but it isn't enough," Oregon Congressman Earl Blumenauer wrote in a statement. "Anything less than descheduling will only continue to trap marijuana businesses between state and federal laws. It's unfair and wrong. To provide the necessary certainty marijuana businesses need, marijuana should be removed from the schedule altogether."

So when, if ever, will marijuana be legal at the federal level? Some expect it to take many years, but Bill Piper of the pro-legalization group Drug Policy Alliance thinks that this year's elections will be critical. Voters in four states, including California, are set to decide on legalizing recreational use. That could force either the new administration or members of Congress to make a radical move towards full legalization. "I think of 2016 as the game over year," Piper says. "Going into 2017, it just becomes unsustainable."