By Paul McVoy and Bill Taylor | Principals, Research & Development Tax Credits
A recent proposal by the Drug Enforcement Agency (DEA) to reclassify marijuana from a Schedule I to a Schedule III drug represents a significant shift in the regulatory framework surrounding cannabis. This change could have profound effects on companies operating within the marijuana industry due to the implications for Internal Revenue Code (IRC) Section 280E.
Section 280E currently prohibits deductions and credits for businesses involved in the trafficking of controlled substances listed under Schedule I and II, which include drugs deemed to have high abuse potential and no accepted medical use. This classification has historically placed substantial financial and operational burdens on cannabis companies.
With the DEA’s proposal to downgrade marijuana to Schedule III—a category for substances with a lower potential for abuse and recognized medical uses—cannabis would no longer fall under the stringent restrictions of Section 280E. Consequently, cannabis businesses could deduct costs such as salaries, rent, and utilities, which were previously non-deductible. Furthermore, this reclassification would allow cannabis companies to claim federal deductions and credits, including the Research & Development (R&D) Tax Credit.
This opportunity could encourage more investment in developing new cultivation techniques, creating strains with better medicinal benefits, and innovating in product delivery. The removal of these tax barriers can spur innovation, fuel economic growth, and enhance the competitive edge of cannabis businesses in the rapidly evolving market.
What is the R&D Tax Credit?
The Research and Development Tax Credit is a reduction in federal tax liability that companies can take for approved domestic expenses. This is a dollar-for-dollar rate of reduction. You also get back approximately 13 cents for every dollar spent on research that meets the eligibility requirements. Qualifying research and development expenses include the development, improvement, or design of a product, technique, process, or software.
This credit can lead to significant savings that free up cash for further R&D, hiring new employees, and more. For companies that meet the criteria of a Qualified Small Business, the R&D credit can be used to offset quarterly payroll taxes. For tax years 2016 through 2022, the maximum R&D tax credit for payroll tax was $250,000. The credit doubled to $500,000 beginning January 1, 2023. Many states have also enacted an R&D credit.
What are the State Benefits?
Aside from the federal R&D tax credit, certain states also offer their own R&D credit for product, process, or software development. While many states align closely with federal rules, some require separate applications and impose industry-specific restrictions or caps on annual credits.
State-level credits can also surpass federal credits, as they may offer higher rates, allow credits to transfer, or even provide cash value regardless of tax liability. Understanding these nuances is crucial to navigating R&D tax credits and ensures taxpayers capture the maximum amount of benefits offered by individual states.
About the Authors
Paul McVoy | Principal – Research & Development Tax Credits
Paul McVoy is a Principal for KBKG’s Tax Credit Consulting practice. In this role, Paul devotes his time to consulting companies in maximizing their R&D tax credit claims. Prior to joining KBKG, Paul was a manager at a Big Four accounting firm out of the Philadelphia, San Diego, and Los Angeles offices. Paul McVoy has spent more than 14 years. Read More
Bill Taylor | Principal – Research & Development Tax Credits
Bill Taylor is a Principal for KBKG’s Research and Development (R&D) Tax Credit Consulting practice. Based in Dallas, TX, Bill has over 10 years of experience providing federal tax consulting services to companies of all sizes within various industries, including technology, aerospace and defense, manufacturing, oil and gas, gaming, banking, and other professional services. Read More