Oakland’s Harborside Health Center — the largest medical marijuana dispensary on the West Coast — lost the first round in a high-stakes battle with the Internal Revenue Service that could spell trouble for the booming pot industry.
In a letter to Harborside late last week, the IRS ruled that the dispensary cannot deduct standard business expenses such as payroll and rent, because it is involved in what the agency terms "the trafficking of controlled substances," said Luigi Zamarra, Harborside’s chief financial officer.
“We can't live with the conclusions that the IRS has come to and neither can the industry,” Zamarra said in an interview Monday. If the IRS ultimately prevails, “we would close our doors and go away because the business model wouldn’t work,” he said.
Zamarra said Harborside would appeal the ruling. An IRS spokesman declined to comment.
The ruling highlights the conflict between federal and state authorities over medical marijuana, which is legal under state law but illegal under federal law. As Oakland and other cities have looked to dispensaries as sources for much-needed tax revenue, the federal government has toughened its stance toward the state’s marijuana industry.
Harborside — which has more 83,000 members and raked in $22 million at its Oakland dispensary last year — received a letter from the IRS late last week saying that the dispensary owed $2.5 million in taxes from 2007 and 2008. That’s $2 million more than Harborside paid for those tax years, Zamarra said.
The difference: The IRS insists that medical marijuana dispensaries must obey a section of tax code that prohibits companies from deducting most expenses if they are “trafficking in controlled substances.” The section, 280e, was designed as a tool for fighting drug trafficking.
Zamarra said that the IRS letter states that Harborside can’t deduct rent, payroll, health insurance or worker’s compensation insurance — deductions that are standard for many other industries. The only two things the IRS says the dispensary can deduct are the cost of buying marijuana and the cost of alternative health care services such as yoga, he said.
For instance, if Harborside bought marijuana for $60, sold it for $100 and used the entire $40 in income to pay salaries, rent and other expenses, the IRS would still demand that Harborside pay 35 percent tax on the $40, Zamarra said.
Richard Lee, who runs a downtown Oakland dispensary and is president of Oaksterdam University, which provides training to budding potrepreneurs, said the ruling would be a serious blow to the industry when added to increased local taxes and regular state and federal taxes.
The IRS began auditing Harboriside two years ago, as The Bay Citizen first reported. Last week's decision came after months of apprehensive waiting, Zamarra said.
Although the IRS ruled against Harborside on the 280e issue, Zamarra said that that the auditors aren’t questioning whether the dispensary’s books are clean. Other dispensaries, like New Age Healing Collective in San Jose, have landed in hot water for allegedly cooking their books to hide the rivers of cash flowing in.
“Harborside Health Center is very proud that they are not questioning our gross income or the details of our expenses,” said Zamarra. “The IRS has accepted our accounting.”
On the same day that it announced its loss to the IRS, Harborside also announced that it had handed over the last installment of its $1,081,450 tax bill to the city of Oakland, which now collects a 5 percent tax on marijuana dispensaries.
East Bay Congressman Pete Stark introduced a bill this spring that would change the federal tax code to allow medical marijuana dispensaries to make the same deductions as normal businesses.
"Our tax code undercuts legal medical marijuana dispensaries by preventing them from taking all the deductions allowed for other small businesses,” Stark said at the time.
But with the federal opposition to marijuana dispensaries, it’s unclear whether the president would sign the bill.
“The Obama administration is really on the counterattack right now, so I’m not sure what will happen,” Oaksterdam's Lee said.
Lee declined to comment on whether the IRS had raised the same issues with his dispensary. But Lee said Harborside’s battle with the IRS shows that the medical marijuana industry is making progress.
“At least it's better to be bankrupted than incarcerated,” he said.