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Minnesota marijuana businesses hope to benefit from proposed federal classification downgrade; worry about outstate competition

HHS sent a formal request that DEA move marijuana from its schedule I list of drugs to schedule III.

Marijuana flower
The federal Department of Health and Human Services has sent a formal request that the Drug Enforcement Administration move marijuana from its schedule I list of drugs to schedule III.

It might sound like a government action that only a bureaucrat could love: a request by one federal agency to another federal agency asking it to change how it classifies a drug.

But a letter this week from the federal Department of Health and Human Services (HHS) and the Drug Enforcement Administration could make it easier and more profitable for Minnesota companies to get into the legal marijuana business. People close to the legal cannabis business say it could have significant implications for how marijuana businesses pay taxes, get banking services and buy insurance.

As first reported by Bloomberg News on Wednesday, HHS sent a formal request that DEA move marijuana from its schedule I list of drugs to schedule III. That would shift marijuana from a group that includes heroin, LSD and ecstasy to one that includes drugs like Tylenol with codeine, ketamine, anabolic steroids and testosterone.

Bloomberg also noted that when word of the HHS request got out, the stock prices of marijuana-related companies surged. It reported that the MJ Pure Play 100 Index of cannabis stocks jumped 13%, the biggest increase since October. That could be driven by the tax implications but publicly traded companies also would benefit if the change opens up interstate commerce.

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“This change could bring in more out-of-state competition,” said Ryan Winkler, the former House Majority Leader and chair of the MN is Ready legalization coalition. “But it could also make it easier for cannabis companies in Minnesota to be profitable by reducing the tax on the federal level … It moves toward normalizing cannabis as a business, which means that it’s both more competitive and potentially more profitable.”

Shawn Weber is the owner of Crested River in Morgan, Minnesota and the president of the Minnesota Cannabis Growers Cooperative & Industry Council. He said the request, if agreed to by the DEA, would improve the financial prospects of new recreational marijuana businesses.

“It affects their bottom line, their access to capital and overall the ability to operate like a normal business,” Weber said. “That is the biggest hiccup between being in the cannabis space and not being in a cannabis space.”

Hemp was allowed to be grown by the 2018 federal Farm Bill as long as the THC content was below 0.3%. In 2022, Minnesota legalized many intoxicating products that are produced by enhancing that THC content. Neither is illegal under federal law and hemp companies do not have the same banking restrictions and taxation differences as marijuana companies.

But what is termed “rescheduling” could produce significant benefits for businesses in the 38 medical marijuana states and the 23 recreational marijuana states. While Minnesota does not yet have licensed recreational marijuana businesses (two Indigenous tribes, Red Lake and White Earth, currently operate through an agreement made with Gov. Tim Walz), the 18-month process of writing rules and issuing licenses has begun and people interested in getting them are developing business plans and seeking capital. Where the drug is placed on the DEA schedule could change everything, including applying for loans and even leasing space.

“The scheduling has been an incredible impediment for banking, loans insurance,” said Leili Fatehi, a partner in Blunt Strategies and a leader of the MN is Ready legalization campaign. “There’s a domino effect. Folks want to get a lease on a retail space and if the owner has a mortgage with a national bank, they might hear back from the landlord saying we can’t lease to you.

“The rescheduling hopefully begins to pretty quickly resolve some of those issues,” she said. “It allows these guys to access the basic business infrastructure that is available to every other line of business. But it doesn’t entirely fix all the issues.”

The Minnesota Credit Union Network said this in response to questions as to how the scheduling change might change banking’s approach to cannabis businesses: “The current status of federal law puts credit unions in a difficult position to serve their mission and members while remaining compliant. Minnesota credit unions will not jeopardize the stewardship and fiduciary obligations that their cooperative members (who own the credit union) entrust to them. We continue encouraging Congress to pass the SAFE Banking Act to protect financial institutions, businesses and communities.”

The request from HHS followed a scientific and medical review of marijuana by the Food and Drug Administration, Bloomberg reported. The DEA makes the final decision on how drugs are regulated under the Controlled Substances Act.  And a request from HHS to DEA is just that, a request. DEA can, as it has as recently as 2016, decide to keep marijuana on Schedule I.

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Still, the HHS request for a scheduling change is the second significant move by the Biden administration to change the federal approach to marijuana. This past October, President Biden pardoned all people with federal convictions for simple possession.

Both stand in contrast to a history of federal-state conflict over marijuana. A decade after Colorado and Washington legalized recreational use via voter initiatives, 21 other states have legalized, and 23 years after California became the first of 38 states with a medical marijuana program, the federal government has remained steadfast against both.

Marijuana plants and products that have THC concentrations of 0.3% and higher would still be illegal at the federal level. Drugs on the Schedule III list still require FDA approval of products and a doctor’s prescription.

“State-legal marijuana programs will still exist, but rescheduling will not make them legal,” said an analysis by national law firm McGlinchey. “Instead, it will make them a little less illegal, as the penalties associated with Schedule III substances are far less severe than Schedule I substances.”

Winkler said the direct effect of the change relates to how the Food and Drug Administration responds to requests to research cannabis and to applications for approval of cannabis-related drugs. But the change would be a next step toward federal legalization, something he favors.

Hurdles for marijuana businesses

As a schedule I drug, defined by federal law as being highly addictive and having no medical benefits, marijuana businesses even in states where it is legal could not claim most business expenses on federal taxation. In addition, national and regional banks regulated by the federal government could not do business with companies growing, manufacturing or selling marijuana. That also meant that many marijuana retailers were relegated to being cash businesses. A federal bill called the SAFE Banking Act is also attempting to make access to financial services easier for marijuana businesses.

Changing the scheduling, however, could produce similar banking gains and could open the door for companies to deduct more expenses from their federal income taxes. An IRS code provision known as 280E prohibits deductions common to other businesses such as equipment, payroll, accounting and legal services and marketing

“The deduction is a very big deal,” Fatehi said. A provision in Minnesota’s law, those expenses will be deductions for state income taxes, however.

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Because hemp and hemp products are legal federally, those businesses can take those deductions on both federal and Minnesota taxes.

Insurance companies have also been reluctant to do business with what are still considered federally illegal businesses. Rescheduling could make getting insurance easier, perhaps cheaper as well.

In addition, numerous court cases that came out against marijuana-related parties simply because the drug was classified as the most-dangerous of substances could see different outcomes if the same issues are litigated after rescheduling. And a scheduling change will open up more avenues for medical and scientific research into marijuana.

During the drafting and amending of House Fill 100, the presence of marijuana on the DEA’s schedule I list of drugs created complications. The bill was changed many times to allow for some businesses to stay clearly on the hemp side of the business in order to preserve their ability to deduct expenses, bring products in from other states and secure financial services.

Businesses can be in both hemp and marijuana and Weber said Crested River will consider doing that. But it would have to make sure the accounting makes it clear which is which – a complication and cost that might lead some businesses to do one or the other, but not both.

In addition, the lack of access to banking led bill sponsors to create a $3 million grant and loan program called CanStartup to help people start small businesses – especially people from communities who suffered the most from criminal prosecutions of marijuana.

“They not only have difficulty getting loans but they have had to deal with predatory lending in the context of cannabis so it’s appropriate for government to provide safeguards through some of these grant programs,” Fatehi said.

Weber said the impacts of a scheduling change are still mostly unknown and could have what he called cascading effects on marijuana businesses, law and research. He said he does have one worry: If a rescheduling of marijuana opens the door to interstate trade in recreational cannabis, it could give big national companies a competitive advantage over small and new businesses.

Currently, Minnesota’s law prohibits the import of marijuana and marijuana based products from other states and nations. But if it is no longer illegal federally, the Commerce Clause of the U.S. Constitution could block states from giving in-state businesses such protections.

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“That could be very detrimental to our industry,” Weber said. “Now the big money can flood in. We’d have to play with all these large, out-of-state companies that have done nothing but come in after we’ve done all the work. That’s the only scary thing that could be coming from this.”

Winkler said that HF100 tried to keep the marijuana business small and local, an effort that was helped by the schedule I status of the drug. That could change.

“Because cannabis is a schedule I drug, under federal law it is illegal to trade in the product across state lines,” he said. “One of the goals in Minnesota was to promote a Minnesota-based industry, but if interstate commerce is legal then multi-state or multi-national companies could sue to have open access to our markets. Schedule III removes the interstate commerce prohibition.”