The Feds, Cannabis and Hemp: Imperfect Together

Jul 23, 2018 | Blog

An estimated $8.5 billion was spent on legal cannabis in the United States last year. However, even this amount is a drop in the bucket compared to projections for the next several years. Those projections range from a ‘low’ of $23.4 billion to as much as $44.4 billion by the year 2022 if the full economic impact of the marijuana industry is factored into the calculation. Much like lotteries have become for cash strapped states, cannabis and hemp sales, on a taxable basis, are equally a potentially huge revenue source for years to come. Not surprisingly then some 20 states have legalized marijuana for medical use, while another 9 states and Washington, D.C., now allow it for recreational purposes too. Additional states are also currently considering legislation for legalization of cannabis, at least for medical use, as well as industrial hemp production. With polls showing that some two-thirds of Americans believe marijuana use should be decriminalized, the move, at least at the state level, towards its legalization is not particularly surprising. Correspondingly, more members of Congress have moved towards supporting “states’ rights” for marijuana legalization.

Yet, at the upper echelons of Washington the picture remains uncertain. It is well known that Attorney General Sessions demonizes any legalized use whatsoever of marijuana and has threatened to prosecute users, as well as suppliers, of legalized cannabis in those states allowing its use. President Trump has rarely been steadfast in his positions on a number of fronts, including on the subject of the marijuana legalization. During his campaign he made it fairly clear that he did not support such a move at the federal level. But, just this past month, he suddenly said he would “probably” support a new bipartisan bill proposed by Senators Cory Gardner (CO GOP) and Elizabeth Warren (MA DEM) calling for its legalization.

Meanwhile the cannabis and hemp industries remain whipsawed by this ongoing mix of messages out of Washington. In the interim, an estimated $132 billion in nationwide tax revenue, job creation of some million projected new jobs, and a stymied lending community hang in the balance.

A. Legislation:

At the federal level there are a series of bills currently pending before Congress that would impact the issue of the legalization of either or both of cannabis and hemp. However, no definitive action has taken place on these bills as yet (with the exception of the hemp-related bill). With upcoming mid-term elections and remaining significant divisions in both houses of Congress it is unlikely that until the elections pass much will be accomplished on these bills other than maybe some movement in committees. That said, it is worth noting some of the better known legislation for tracking purposes, if nothing else:

  1. Marijuana Justice Act of 2017 (S.1689; H.R. 4815): Senator Cory Booker originally proposed this bill in August of this past year. This legislation focuses on criminal justice reforms related to marijuana offenses as well as legalization of marijuana use at the federal level.
  2. Marijuana Freedom and Opportunity Act (No Bill Designation Yet): Senator Charles Schumer introduced this legislation just a few weeks ago. Since Senator Schumer was, in the past, a very vocal supporter of drug enforcement efforts this bill has added to the surprise level of federal politicians moving towards the federal legalization of marijuana use. This bill focuses on removing marijuana from the schedule of controlled substances, decriminalizing its use at the federal level, and allowing states to continue to decide on their own how to regulate its use within their borders. This bill now competes with both Senator Booker’s as well as that of Senators Gardner and Warren.
  3. Strengthening the Tenth Amendment Through Entrusting the States Act (a/k/a the STATES Act) (S. 3032; H.R. 6043): This is the bi-partisan bill introduced by Senators Gardner and Warren in early-June of this year. This legislation focuses on (i) generally deferring to the states on the issue of marijuana use legalization and (ii) allowing all banks to provide services to legal marijuana businesses.

B. Hemp:

Hemp, or, better stated, industrial hemp, is a variety of the cannabis plant that is grown specifically for industrial uses. Hemp can be refined into a variety of commercial products including paper, clothing, various textiles, plastics (biodegradable), biofuel, food, etc. Hemp while derived from the cannabis plant has significantly lower concentrations of tetrahydrocannabinol (THC), the component of cannabis that gives it its psychoactive effects. Nonetheless, confusion has existed for years as to whether industrial hemp is also included as a precluded drug, like marijuana, under the Controlled Substances Act of 1970 (CSA). Murkiness has developed since the CSA from the language of the Act as well as corresponding court interpretations and that of state and federal agencies since 1970. While a global market of an estimated 25,000 hemp products has developed, the federal government has essentially prohibited industrial hemp production for commercial purposes. Currently, federal law authorizes farming of hemp for “research only” and not commercial purposes and only by designated research institutions or state pilot programs. Yet, a number of states here in the U.S. have developed commercial hemp markets while essentially ignoring federal law and practice. In fact, some 35 states have passed laws legalizing industrial hemp cultivation or production, including the states of California, Colorado, Tennessee, South Carolina, Virginia, West Virginia, Wyoming, Maryland, Massachusetts, and Maine. In short, the effect of federal law and practice on commercial hemp is regularly being neutralized at the individual, local and state levels.

In an attempt to end confusion and uncertainty with respect to the business of commercial hemp production (and to encourage replacement of his states lost cigarette-production jobs and revenue), Senator Mitch McConnell introduced the bi-partisan Hemp Farming Act of 2018 (S. 2667; H.R. 5485) this past month by including it in the Agricultural Improvement Act of 2018 (the Senate’s version of the Farm Bill). This legislation seeks federal legalization of hemp cultivation and production. It would treat hemp as just another agricultural commodity and give states as well as Indian tribes “primary regulatory authority” over hemp cultivation and production with plan approvals from the Secretary of Agriculture. The bill specifically removes and excludes hemp from the list of controlled substances under the CSA.

Given Senator McConnell’s support of the bill, as Senate Majority leader, and the bi-partisan nature of the legislation, it quickly passed the Senate at the end of this past month. Action in the House on their corresponding bill awaits. If passed the bill is likely to receive quick resolution before committee before moving to the President for consideration and enactment.

C. The Federal Drug Administration:

Interestingly, while the White House has vacillated on its support of legalization of marijuana at the federal level, agencies within the Administration have taken steps to legalize its use in other ways. The Federal Drug Administration (FDA), in particular appears to be working at cross hairs with the Administration, or at least Attorney General Sessions anyway. For instance, the FDA recently denied a request made by an anti-legalization group, Drug Watch International, to place marijuana, and its derivatives, on a list of restricted substances that allegedly are not “generally recognized as safe and effective.”  More notably, just this past month, the FDA also approved the use of a drug specifically derived from marijuana. The drug Epidiolex has been shown in clinical trials to reduce the frequency of seizures in patients with certain forms of epilepsy. The key active ingredient in Epidiolex is cannabis-derived cannabidiol (CBD). While the FDA has previously approved drugs (e.g., Cesamet and Marinol) containing compounds of cannabis, Epidiolex is the first to be made from cannabis itself as opposed to some synthetic version of it. This raises the odd reality that the FDA has now approved the use of a drug developed from a specifically forbidden controlled substance under the CSA. This puts the federal Drug Enforcement Agency in the somewhat awkward position of now having to determine if CBD needs to be rescheduled under the CSA. That determination should come within the next 90 days. For those involved in the cannabis and hemp industries, the DEA’s action over the next three months bears close watching.

D. The Federal Tax Man Cometh:

Somewhat hypocritically, while the federal government continues to treat cannabis as an illegal controlled substance under the CSA, and deny businesses in the industry access to the banking community, the Internal Revenue Service (IRS)  has not hesitated to tax this “illegal” industry and to expect it to comply with the book keeping and filing responsibilities of businesses operating in the U.S. generally. For anyone operating a business in the industry, you would be well advised to become proficient with the recent United States Tax Court ruling in its Opinion in Alterman & Gibson v. Commissioner, T.C. Memo 2018-83. This ruling involved income tax deficiencies and penalties imposed by the IRS for 2010 and 2011 against individual taxpayers who owned and operated a Colorado cannabis dispensary. The Opinion provides something of a roadmap as to how a cannabis business should not be operated from a tax standpoint. In this instance, the taxpayers lost on virtually every issue based, in part, on their poor job of maintaining appropriate financial and inventory records. As such, the case highlights critical recordkeeping, reporting requirements compliance, and the maintenance of an expected system of internal accounting controls. In short, “illegal” or not at the federal level, the IRS will treat any business operating a “legal” cannabis (and, presumably, hemp) business like any other business for tax purposes; as ironic as that might sound given the current view of the marijuana and hemp industries under the present Administration.

Should you have any questions on any of the above or the laws and regulations as they apply to the cannabis and hemp industries please feel free to contact Eric Sleeper.