The cost-benefit of rescheduling cannabis

This story was originally published on CFO.com. To receive daily news and insights, subscribe to our free daily CFO.com newsletter.

Cannabis products have undergone legalization processes in several states, making the legal and financial challenges arising from varying rollout processes, differences in state legality and the federal government’s Schedule I classification of cannabis an intriguing topic for CFOs navigating complex regulatory and market conditions in other industries.

Section 280E of the U.S. tax code complicates cannabis accounting because businesses cannot deduct standard expenses such as rent, payroll or marketing due to cannabis being federally illegal. Accountants must meticulously separate and allocate costs of goods sold, which are deductible, from all other nondeductible expenses to minimize tax liability and ensure compliance.

This labor-intensive process, from an accounting perspective, has generated a demand for accountants and fractional CFOs who specialize in this area. While accountants responding to this demand agree that rescheduling cannabis from a Schedule I narcotic to a Schedule III narcotic may help alleviate some accounting pressures, a top cannabis lawyer says the move may upend the industry.

As the regulatory environment continues to develop alongside the economic decision-making of local regulators state by state — some of which has resulted in market saturation due to open licensing, thriving illegal markets and overbearing regulation on licensing — cannabis’ need for strong financial talent continues to grow in order to manage the multiple trends impacting industry development.

While every cannabis accountant CFO.com spoke to about rescheduling said they support it because of the challenges 280E creates for cannabis companies, legal experts in cannabis say a major portion of the law is being overlooked by this group. Jeffrey Hoffman, who operates one of the largest cannabis-centric legal practices in New York, advised CPAs that the alleviation of 280E that comes with rescheduling may also come with Big Pharma upending their industry.

As Hoffman put it from a legal perspective at the federal level, rescheduling will have cannabis shift from being “treated like heroin” to being treated like “Tylenol with codeine.”

“It’s the pharmaceutical companies who are allowed to make and sell Tylenol with codeine [for example],” said Hoffman. “There’s no way the mom-and-pop cannabis operators who are already struggling under the current rules are going to be able to suddenly get a pharmaceutical manufacturing license to produce this stuff.”

Hoffman argues that rescheduling “hands the entire thing over to Big Pharma and Big Tech.” He said not only will it upend the industry, but it will also impact his career.

“If rescheduling happens, I’m going to need a new job,” Hoffman said. “[Hypothetically], I’ll go become general counsel at one of those [pharmaceutical] companies, and the first thing I’ll do is sue every state that has any sort of state-legal cannabis program, because the only reason those lawsuits don’t exist right now is because cannabis is Schedule I, federally illegal.”

He added that the “calculus changes overnight” once rescheduling begins. Hoffman explained how Big Pharma can argue they are harmed if cannabis moves to a Schedule III product. He said states all over the country are currently letting others sell cannabis under a “totally different system” that’s creating a situation for a “textbook lawsuit.” He said if cannabis is Schedule III, there is a completely valid argument that all of the state-run cannabis programs are “taking money out of Big Pharma’s pockets.”

“The scary part of this lawsuit is that it’s a slam dunk, I don’t think it even goes to trial,” Hoffman said. “I think it wins at summary judgment because it’s not complicated. If, for example, Pfizer or CVS is the only one federally licensed to sell a Schedule III product in a state, and your state is running a whole industry around [then-rescheduled] cannabis, they will sue you. They will ask for damages. They will get a court order to shut it all down — the dispensaries, growers and product manufacturers will be gone.”

Hoffman suggested the jargon of rescheduling and descheduling should be ditched by those in cannabis. “My term is unscheduling,” he said. “That means legalize it and sell it like lettuce.”

However, tax professionals in the space disagree with Hoffman and said Big Pharma has other industries that are much more profitable than cannabis on their radar. Mike Goral, a CPA who leads the cannabis practice at Armanino, said that GLP-1 drugs will deter this type of thing from happening if rescheduling happens.

However, he does believe the multi-state operators are ripe for growth because of the opportunities that will be had in the market should a rescheduling occur. These MSOs are cannabis companies that operate in multiple U.S. states, typically overseeing cultivation, manufacturing, distribution and retail. But, because federal law prohibits cannabis from being shipped across state lines, MSOs must build and manage separate operations in each state where they’re licensed to do business, reducing the benefits of having large scale operations.

“I don’t think Big Pharma will take over,” Goral said. “They’re laser-focused on weight loss drugs like Ozempic, which have way more commercial potential. They’re not wasting time on cannabis. But big MSOs — they’ll get bigger. It’s like craft beer versus big breweries. The large MSOs can raise capital and will likely buy up smaller brands in places like Florida or Pennsylvania to expand their offerings.”

Goral said rescheduling is inevitable, and it’s just a matter of time for these opportunities to come about. This has allowed him to share positive sentiment with his clients on the outlook of the industry lately.

“I think rescheduling will eventually happen. It’s been debated for over a decade, and every time we think we’re close, it stalls,” he said. “The Trump administration has sent mixed signals. Robert F. Kennedy Jr. supports rescheduling, but Trump’s DEA appointee doesn’t. So we’ll see.”

While 280E remains a thorn in the side of cannabis accounting, Hoffman argues that using rescheduling as a means to repeal 280E is an oversight by accountants.

“Maybe it solves 280E, but the flip side is that it’s a massive giveaway to the pharmaceutical industry — and it could completely wipe out the cannabis industry as we know it,” Hoffman said. “It wouldn’t just be one company. You’d see class actions, multidistrict litigation, injunctions — it would be open season, and all of this could unfold before people in the industry even fully realize what just happened.”

Andrew Hunzicker, a CPA and founder of DOPE CFO, a training program for accounting professionals who want to service cannabis businesses, says he believes 280E’s repeal via rescheduling is inevitable and will be a tremendous catalyst for growth in the cannabis industry. He says that while some investors view cannabis as a money grab, playing the long game — including waiting out 280E — is the approach he advises his clients.

“Eventually, 280E is going to go away, and Viridian estimates that once 280E is gone, cannabis company valuations could jump [tremendously] overnight,” said Hunzicker. “Say you own a dispensary and, for five years, you make nothing or even lose $1 million. Then cannabis goes fully legal, 280E goes away, your cash flow increases and suddenly your dispensary goes from being valued at one times sales to four times sales, and you cash out for $25 million. Are you going to care about the $1 million loss in those first five years? No, and that’s typical among startups.”

He said playing the long game is pivotal for businesses looking to entrench themselves in cannabis markets, which is part of the reason why the industry continues to be so capital intensive.

“When I counsel people who want to get into this industry, I tell them, ‘don’t expect a gold rush,’” Hunzicker said. “You’re going to open a dispensary, and even if you do everything right, you’re probably just breaking even or maybe making a little profit. Depending on how well you run your store, you might be slightly profitable or taking a small loss, and that’s OK because you’re playing the long game.”

Other CPAs who have built careers around cannabis agree with Hunzicker, but say 280E’s repeal is only part of the challenge of cannabis accounting. Brenda Bader, owner of Gold Leaf Accounting in Missouri, which has been praised as one of the few states to get the cannabis rollout right, says the scheduling of cannabis creates more problems than the ones caused by 280E’s stipulation.

“Since it’s not federally legal, businesses can still have a hard time finding merchant services — credit card processing, for example, or even certain software providers,” Bader said. “Things are starting to change now, but five years ago, QuickBooks would kick you off their platform if they knew you were cannabis-related. Now they’re one of the biggest software providers in the space.”

Bader detailed how she believes the entire business infrastructure of the cannabis industry has changed over the last three years. However, she says the costs of doing business still remain high when compared to other types of industries.

“I’m also an insurance agent and run a small brokerage, and I can tell you cannabis insurance costs about three times more than what a regular retailer, farmer or manufacturer would pay,” Bader said. “The risk is higher, so the companies willing to get into the space are taking a big chance, but they’re doing it because it’s a fast-growing niche. They’re not federally backed, so if something goes wrong, they’re on the hook. It’s risky.”

She said the scheduling of cannabis has also impeded some companies in the industry when it comes to raising money and getting access to capital. However, unlike Goral, Bader said she believes investors are less interested in MSOs and more interested in local growers.

“I’ve started to help with capital raises a little, and what I’ve noticed is that investors are shying away from the MSOs now. They’re looking for local Midwest operators instead. I’ve had multiple investors tell me, ‘If you find someone local, bring them to me,’” she said.

Bader said cannabis continues to be one of the most capital-intensive, financially complex industries. Due to this, she isn’t worried about her business’ future should rescheduling occur.

“I’ve been a controller and CFO for years, and one thing I’ve consistently seen is that cannabis is still a cash-heavy business,” Bader said. “I don’t care how many cards or digital payments are out there, there’s still a lot of cash involved, so I don’t expect my job to change much at all [if rescheduling happens]. Cannabis businesses will still need someone who knows what they’re doing — whether they think they do or not.”

Recommended Reading