CBD is Almost Legal!?

by Brian S. Whalen, CPA December 01, 2018
Estimated Reading Time: 7 minutes

Any day now (now is December 18′) the 2018 Farm Bill might pass, and it intends to legalize the cultivation of hemp in all states.  In the meantime, we have a convoluted set of rules that tell us which CBD is federally legal but does not tell us whether or not legal CBD remains Schedule I and subject to § 280E.  We will explain in detail that CBD is in fact Schedule I and thereby subject to § 280E unless it is subject to specific exceptions, in which case it may or may not be subject to § 280E.  § 280E is in the eye of the beholder as you will see.

We don’t care if you saw on Instagram that “CBD is now legal in all 50 states” and neither will the IRS if your source of CBD is not documented to be from a federally “legal” source.  Many CBD businesses are doing themselves a disservice by not understanding the regulatory landscape.  Don’t take us the wrong way; we know it’s not your fault that there is no specific guidance from the IRS and plenty of bogus information on the internet, but we hope to clear some of that up for you.  If your CBD does not fall within the specified exceptions provided by the 2014 Farm Bill and the DEA, then you will receive the same treatment as a THC business.  Let’s get into the details…

CBD / industrial hemp is legal if produced in accordance with federal law, but at the same time could be subject to § 280E if deemed Schedule I by the IRS.  The interpretation of whether “industrial hemp” and its derivatives are Schedule I depends on who you ask and could change any day (with pending legislation).  In September 2018, an Administrative Law Judge with the U.S. Postal service finally ruled in favor of the mailability of CBD that is protected by the 2014 Farm Bill, stating that it is not Schedule I.  This stemmed from a case where the USPS confiscated a shipment.  It took this long just to figure out that you can ship “legal” CBD, but the Postal Service’s decision has no impact on the IRS’s interpretation of the matter.

The Agricultural Act of 2014 also known as the 2014 Farm Bill expired on September 30th, 2018.  At the time of this writing, we are waiting on proposed legislation which would legalize the cultivation of all industrial hemp and potentially legalize all hemp derived CBD.  The Hemp Farming Act of 2018 is attached to the 2018 Farm Bill and, if passed, may remove cannabis that does not exceed 0.3% THC from Schedule I of the Controlled Substances Act, adding it to the mundane list of agricultural commodities.  This would potentially relieve all industrial hemp and its derivatives (CBD) from the perils of § 280E.  Can you envision CBD for sale at Walgreens for $9.99?  (How the FDA will regulate CBD is beyond the scope of this article.)

It seems that industrial hemp/ CBD may be legal and Schedule I at the same time!

Where do we stand in the meantime?  In muddy waters, unfortunately.  Let’s start with the facts.  The DEA issued a directive on May 22, 2018, to acknowledge that the 2014 Farm Bill preempts the Controlled Substances Act where the two conflict.  Therefore, “industrial hemp” that is cultivated pursuant to a state pilot program is protected by the 2014 Farm Bill, and any derived CBD would be protected as well.  Most states (41 at present) have laws that allow the growing of industrial hemp under such a program.

We can turn to the law that codified the 2014 Farm Bill, 7 U.S. Code § 5940 – Legitimacy of industrial hemp research (derived from section 7606 of the Agricultural Act of 2014), to see that it is legal to grow industrial hemp which is cultivated pursuant to a state permitted agricultural pilot program or in an institution of higher education for the purpose of researching the growth, cultivation, or marketing of industrial hemp.  The DEA conceded, and the Court agreed, that the Farm Bill of 2014 supersedes the DEA’s authority under the Controlled Substances Act as it relates to hemp. The first line of this section § 5940, however, begins, “Notwithstanding the Controlled Substances Act” – can you see where we are going with this?

Sure, its legal to grow industrial hemp and extract CBD from it, but “notwithstanding” effectively means despite the Controlled Substances Act.  The 2014 Farm Bill does not explicitly remove industrial hemp from Schedule I but it does provide a legal workaround.  As we know, § 280E applies to Schedule I drugs.  Some will argue that since the 2014 Farm Bill preempts the CSA, then industrial hemp is no longer Schedule I.  The DEA, on the other hand, correctly points out that, “Section 7706 (of the 2014 Farm Bill) did not remove industrial hemp from the controlled substances list”.  As a result, Congress issued an Amicus brief supporting the Hemp Industries Association in their case against the DEA, conveying that the intent of the 2014 Farm Bill was to prompt the DEA to affect the administrative changes necessary to remove industrial hemp from the CSA.  The DEA has not done so to date but has clarified in a May 22, 2018, internal directive that their intent is not to target cannabinoids (a.k.a. CBD), but to enforce only those products which fall under their definition of “marijuana”.  The DEA’s definition of marijuana does not align with the 2014 Farm Bill’s “not to exceed 0.3%” guidance.  While the DEA excludes the mature stalks and sterile seeds from the definition of “marijuana”, they contend that CBD can only be produced from the parts of the plant which are defined as “marijuana” under the Controlled Substances Act.  Specifically, the DEA relies upon outdated (1970’s) scientific literature that suggests that cannabinoids (CBD) can only be derived in excess of parts per million from the illegal parts of the plant.   This leads some to contend that industrial hemp is still subject to § 280E and suggests that you should tread lightly with the IRS.  Auditors may not adopt the position that the expired 2014 Farm Bill removes hemp and hemp derived CBD from Schedule I.

RELATED:  #CannabisCourt Update: Harborside vs. IRS

Congress’s intent is manifested again in The Consolidated Appropriations Act of 2017, which asserts that federal funding may not be used, “to prohibit the transportation, processing, sale, or use of industrial hemp that is grown or cultivated in accordance with section 7606 of the Agricultural Act of 2014, within or outside the State in which the industrial hemp is grown or cultivated.” Said another way, CBD derived from hemp farming activities conducted in full compliance with state pilot programs is federally legal in all 50 states.  It seems that industrial hemp / CBD may be legal and Schedule I at the same time!

There is a way in which CBD can dodge § 280E without doubt, and only one drug that falls into this category to date.

Some CBD is always subject to § 280E.  First, understand that hemp and marijuana are one and the same, both are the genus cannabis sativa.  To demonize the plant, some government folks in the 1930’s forced their anti-immigration sentiment on the plant by calling it by its Mexican name, “marihuana”.  CBD may be derived from either marijuana or hemp.  There is a common misconception that all CBD is federally legal and can be shipped across state lines if it does not exceed 0.3% THC.  On the contrary, not all CBD is federally legal and not all states have adopted industrial hemp programs.  CBD derived from “marijuana” is always Schedule I per the DEA as there is no argument to be made relying on the 2014 Farm Bill.  This would require the IRS to subject it to § 280E and necessitate that it be sold pursuant to state laws at the state legal level (while it remains federally illegal).

In addition, a court case by the name of Hemp Industries Association v. DEA resulted in the exclusion of imported “non-psychoactive hemp” from the Controlled Substances Act.  Also, CBD derived from what the DEA considers to be the legal parts of the cannabis plant is legal.  Take this to mean that the sterilized seeds, oil or cake made from the seeds, and mature stalks are not controlled by the Controlled Substances Act.  This is why you can buy hemp seeds at your local grocery store.  The DEA argues that it is impossible to create CBD in significant quantities from these parts of the plant, which leads to more conflict. The DEA stands by a rule specifically targeting CBD, industrial hemp derived or not, in stating that any “extract containing one or more cannabinoids that have been derived from any plant of the genus Cannabis” is considered a Schedule I.  Yes, the 2014 Farm Bill preempts this, but “notwithstanding the Controlled Substances Act” does not exempt CBD from Schedule I and § 280E, right?

There is a way in which CBD can dodge § 280E without doubt, and only one drug that falls into this category to date.  The DEA agreed that only Food & Drug Administration (FDA) approved drugs with a CBD ingredient that contain less than 0.1% THC will automatically be moved to Schedule V of the CSA.  The DEA has rescheduled a single CBD drug from I to V per the FDA’s approval to date, Epidiolex, which treats epilepsy. Currently, the DEA cannot remove CBD products from being scheduled altogether due to a 47-year-old revision of an international treaty, the Single Convention on Narcotic Drugs. An irrelevant side note:  this means that in states where marijuana is not legal, a patient would technically need a prescription for CBD to be in compliance with state and federal law.

Whether CBD or industrial hemp is subject to § 280E or not, keep in mind that the IRS lives in the past (it may take years before you are audited) and applies the tax laws as written in the years being audited. In other words, ignoring § 280E in 2016-2018 can catch up to you in 2019 even if the punitive tax laws no longer apply to CBD in the future.  For this reason, ensure you have documentation to support the origin of your legal CBD products or take care of your tax liability under § 280E for your federally illegal CBD product sales.  If you are in the gray area, it would be prudent to maintain your inventories via the rules for inventories under IRC § 471, so even if § 280E comes back to bite you, you have the documentation to get some COGS deductions.

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