What is cannabis rescheduling? And how might it affect CPAs?

The AICPA & CIMA Cannabis Industry Conference starts Aug. 12 in Aurora, Colo. Rachel Gillette will be one of the event’s front-and-center speakers and moderators.

Gillette joined the Journal of Accountancy podcast recently to discuss some of the trends and issues affecting the industry from a legal and regulatory perspective. Gillette, a Denver-based attorney, also explained how she ended up in this niche practice area.

What you’ll learn from this episode:

• Background on the proposed rescheduling of cannabis and why it matters for the industry and for accountants who advise cannabis businesses.
• Gillette’s opinion of what might happen with cannabis-related legislation.
• Why potential cannabis rescheduling could mean that certain businesses are no longer subject to Sec. 280E.
• How the potential changes could affect CPAs.
• What Gillette looks forward to about the AICPA & CIMA Cannabis Industry Conference.
• How a decision more than 15 years ago led Gillette to her current area of legal practice.

Play the episode below or read the edited transcript:

— To comment on this episode or to suggest an idea for another episode, contact Neil Amato at Neil.Amato@aicpa-cima.com.

Transcript

Neil Amato: Hello, listeners. Welcome to the Journal of Accountancy podcast. This is Neil Amato with the JofA. Coming up on this episode is a conversation with a keynote speaker and also a moderator at the upcoming AICPA & CIMA Cannabis Industry Conference. You’ll hear all about that fast-moving topic and some of the industry trends affecting CPAs — right after this brief sponsor message.

Welcome back. Our guest for today is Rachel Gillette, an attorney with the Denver-based firm Holland & Hart. The AICPA & CIMA Cannabis Industry Conference is pretty much right in Gillette’s back yard in Aurora, Colorado. August 12 is the start date of that event.

Rachel, thank you for being on the Journal of Accountancy podcast.

Rachel Gillette: Thank you for inviting me, Neil.

Amato: Yeah, we’re glad to have you on. I do want to hit on what you think are some of the hot topics that are going to come up at this conference that, again, at this recording in late June — we’re going to publish in July. The conference, again, [is] Aug. 12.

One of the keynote sessions that you’re moderating is called “Navigating the Impacts of Cannabis Rescheduling.” First, what is cannabis rescheduling?

Gillette: If you’ve been living under a rock and you don’t know about this, basically, for the very first time since the Controlled Substances Act has been in existence, cannabis has the possibility of becoming a Schedule III controlled substance as opposed to its current schedule, which is Schedule I. That means that it will no longer be considered to have no medical applications.

Let’s just say that Schedule I is the most stringent or strict scheduling for any kind of controlled substance. It means that the drug has no accepted medical use and a high potential for abuse. And last year, the HHS, responding to an inquiry by the Biden administration, recommended that cannabis be rescheduled to Schedule III, and that is very big news.

It’s big news for the industry in particular and accountants because a Schedule III designation means that cannabis businesses will no longer be subject to the tax provision of the tax code, which is IRC [Sec.] 280E. We could talk about 280E and other impacts [on] the CPA profession a little bit later.

Amato: That’s a great introduction to the topic. You mentioned HHS; that’s the Department of Health and Human Services. What, in a few, or maybe not a few words, does this rescheduling mean? You touched on the possible tax impact, but what will this mean for businesses that sell and distribute cannabis legally? How does it change things?

Gillette: It’s interesting because there’s a lot of unknowns to how exactly it will change things. But, generally, the rescheduling of cannabis into a Schedule III classification does not fix the conflict between state and federal laws. So, this is not legalizing cannabis federally; that is what it is not.

In fact, the conflicts that currently exist between state and federal laws, meaning states have their own regulatory regimes which legalize medical or adult use cannabis — those are in direct conflict with the federal illegality of cannabis. That situation is unfortunately not going to change with a Schedule III classification.

But I think maybe it’s going to help with banking. Maybe there’ll be more support for passing, in its final form, the SAFER Banking Act, which will allow cannabis businesses to have more normal relationships with banks, and maybe more banks to bank within the cannabis industry.

It could potentially have other impacts, but a lot of those are yet to be known because we don’t know what other potential legislation might come along with this Schedule III designation, because there’s been lots of federal cannabis-related legislation that’s been proposed. Unfortunately, not a lot of it has gone anywhere.

Amato: For our listeners who are new to the subject, can you briefly explain the Cannabis Administration and Opportunity Act and some of its background? I guess it’s a bill that had been around and has now been reintroduced recently?

Gillette: Yeah. There’s actually been a number of proposed bills in Congress. But this one has made more traction, I think. It was actually reintroduced again this year. It is a bill to decriminalize and actually deschedule cannabis and to reinvest in people that have potentially been adversely affected by the war on drugs. It includes provisions to allow for expungement of criminal records and funds for certain community programs and things like that.

One of the things that I think is actually interesting about this act is that it does deal with the issue of conflict between state and federal law, which is something that the Schedule III designation will not do.

I do think that having some clarity at the federal level as to the legality of cannabis is probably beneficial for the industry. But, unfortunately, I’m not sure it has enough support to go anywhere. Who knows? With a changing changing Congress, there can be a lot of changes that potentially go forward. Who knows what will happen six months from now or next year?

Amato: For CPAs who have clients in cannabis businesses, you mentioned that, I don’t know if push and pull is the right phrase, but that balance of federal regulations versus state. What do they need to know that’s new on this front? They’ve dealt with it before, but how is it changing as we get into the second half of 2024?

Gillette: Well, one of the reasons I practice in this area is because cannabis and the law surrounding cannabis is extremely dynamic and constantly changing.

CPAs who practice in this area, I imagine they have clientele that are either plant-touching [licensed businesses that are direct growers, manufacturers, or sellers of cannabis], maybe ancillary to the cannabis industry, maybe their client provides a product or service to the cannabis industry. They may even represent hemp businesses, or people who sell products that are derived from industrial hemp. Even then, there’s potentially some changes that could occur that some CPAs might want to be aware of.

Anyway, the biggest impact, as I mentioned previously with the rescheduling of cannabis for CPAs, is going to be that cannabis businesses, plant-touching entities that traffic in controlled substances are no longer going to be subject to 280E. That’s because IRC 280E only applies to Schedule I and Schedule II under its current interpretation.

A Schedule III designation would mean that it is no longer applicable to state legal cannabis businesses, which is a huge development. I guess the question becomes when does that officially become the case that IRC 280E is no longer applicable?

There is some pending litigation that is occurring right now that could potentially impact 280E. But most people seem to think that 280E is going to go away prospectively. That’s going be the biggest impact, and I’m sure accountants have gotten plenty of brain damage trying to figure out what can be put into cost of goods sold and what can’t, and why it can and can’t.

They’re no longer going to have to do that exercise because cannabis businesses are going to be able to just take ordinary and necessary business deductions like any other business, which is going to help them when it comes to their profitability.

Amato: Besides that 280E issue or change, are there other tax implications on the horizon?

Gillette: I think it’s yet to be seen. One of the things that I wonder about is with a Schedule III designation, are states going to maybe think about regulating a little bit differently? I also wonder if there is going to be some push to tax it on the federal level.

That’s one thing I do fear, which actually Aaron Smith, who’s one of the keynote speakers, could potentially speak on, is whether or not the punitive 280E is going to be replaced by some other horrible federal tax.

I could easily see that occurring. When it will happen? I don’t know. But it’s just one of those things where we don’t really know what may happen going forward. But I do think if there is some kind of federal legalization of cannabis, that there will be some effort to tax it on the federal level.

Amato: You mentioned Aaron Smith with the National Cannabis Industry Association. He will be speaking as a keynote. Obviously, he’s a respected authority on this. Related to the conference, other than Aaron Smith’s words, what are some things maybe you’re looking forward to?

Gillette: Well, first of all, Colorado is just an incredibly beautiful place to visit. I recommend that people who don’t live here come to the conference just for Colorado alone because it’s a great place, and Denver in particular is a really nice place. But as far as the conference goes, I’m looking forward to everything as it relates to cannabis.

I do a lot of tax controversy work. I’m always interested in hearing what CPAs have to say about things going on in the industry. It’s always good to be able to talk with your colleagues [about] the latest and greatest updates of things that are impacting their clients, including IRS audits — what’s happening with IRS audits in the cannabis industry? What is the current tax court litigation surrounding 280E? I think [it’s] interesting.

I think there’s been a lot of discussion and newsworthy things that have occurred of late in the realm of refund claims, which I’m not sure if you’re familiar, but there was some big news that Trulieve had taken a position that they were not subject to 280E and therefore applied for some refunds and actually got some refunds. There’s been a lot of hubbub about that. People have a lot of different thoughts on that subject.

I’m looking forward to getting together with my colleagues and people that work in the tax space and see what’s been going on across the country as it relates to cannabis.

Amato: You mentioned that phrase: tax controversy. That’s been an area of focus for you. But cannabis itself is a pretty niche area. How many years have you been involved in it, and what attracted you to it?

Gillette: I actually graduated law school in my 30s. I graduated in the great year of 2007, which was right before the Great Recession. The nice thing [laughing] about graduating with the Great Recession is it’s hard to find employment because law firms were letting attorneys go rather than hiring attorneys, especially new attorneys.

I ended up actually getting a job in a tax practice doing tax controversy, which was out of law school. It’s not something that I had ever planned on, but tax controversy is recession-proof because when recessions happen, tax problems happen. That’s where I started, and I did that for two years. That would be assisting people that were being audited or facing selections.

Having graduated law school in the Great Recession and then worked doing tax, in 2010, the state of Colorado was going to be the first state that actually regulated cannabis businesses and licensed cannabis businesses. At the time it was medical marijuana, but we were the first state to ever do that.

Our state legislature passed a law called House Bill 10-1284, and I said: “Well, gee, this is interesting.” It just so happened that the regulatory agency was going to be the Department of Revenue, which I had been dealing with on a regular basis being in tax. But I knew it was a new area of potential practice.

I actually quit my job and decided to focus on representing cannabis license applicants that were going to be applying for these licenses. At the time, there certainly wasn’t clarity that I could do that because cannabis was federally illegal. My law school professor told me I was going to lose my law license at the time.

I took some risks. I had my own practice for six years, and all I did was represent cannabis businesses. I just so happened to have a background in tax, and I was recognizing early in that career that there were a lot of cannabis businesses that were being audited, that were getting penalties for making cash tax deposits, for example.

One of the first cases I did in Tax Court was a case called Allgreens v. Commissioner, where I argued that cannabis businesses should not be subject to the 10% penalty, or should at least be able to have reasonable cause for abatement of a 10% penalty for failure to use the EFTPS [Electronic Federal Tax Payment System]. Because most of them were operating in cash at the time.

The IRS settled that case and actually changed the Internal Revenue Manual to allow for an abatement process for unbanked taxpayers. That was my first big case that actually made some national news. To this day, a lot of people don’t know, including CPAs, that you can get an abatement of that 10% penalty if you have an unbanked taxpayer.

Amato: Wow. Thank you for that, Rachel. The status of that legislation, obviously, if it doesn’t have a ton of support, it’s not going to get passed immediately. We are in an election year, so who knows what happens. But is there anything in your crystal ball, or not, that you think happens with that act?

Gillette: I think in my crystal ball, if I was going to say which federal legislation might pass first, or has the greatest chance of success of passage, is actually the SAFER Banking Act, which will allow banks to more freely, or with more clarity, bank cannabis businesses. I think this type of legislation obviously has some support.

However, I don’t know that federal descheduling of cannabis is high on the priority list of our congresspeople at this moment. There’s a lot of other things maybe taking their attention. I’m not sure where this is going to go or when. Of course, we’re in an election year, so I’m not expecting some grandiose passage of this act before the election or before we know the outcome of who’s going to be in Congress and who’s not.

We’ll see.

Amato: Yeah. Exactly. With a lot of things, we’ll see. Rachel Gillette, thank you very much for being on the JofA podcast.

Gillette: Thank you.