This article highlights a very important issue that I have been preaching about lately — taxes on medical marijuana. As you will read in the story below, the largest dispensary in America is being audited by the IRS. There is an old provision in the tax code that could possibly be used against not only this dispensary, but all organizations that sell marijuana (dispensary, collective, club, etc). Every dispensary that I have talked to, in an honest effort to be legit on the books, have been deducting business expenses like any other business, including cannabis purchases and sales. If the feds have their way, the cannabis related deductions might be a bad thing. Hopefully things work out for the state sovereignty side and not the Big Brother side. Here is the story below:

The Bay Citizen

IRS Auditing Oakland’s Biggest Pot Dispensary

Scrutiny of Harborside could be the opening salvo in a skirmish over medical marijuana law

By Zusha Elinson on December 10, 2010 – 2:11 p.m. PST

In an ominous portent of the clash between federal and state law over medical marijuana, the IRS is auditing the Bay Area’s largest medical pot dispensary, Harborside Health Center, The Bay Citizen has learned.

Steve DeAngelo, executive director of Harborside, said in an interview today that the IRS initiated the audit a few months ago and it has not finished. DeAngelo said he wasn’t worried about opening the dispensary’s books, saying, “Our whole model is being compliant and transparent; I don’t have anything to hide from the IRS.”

An IRS spokesman said the agency doesn’t confirm or deny whether audits are taking place.

However, a Nov. 15 letter that Harborside sent to Sen. Barbara Boxer asking for tweaks in tax laws that can result in near-crippling taxes on pot dispensaries, conveys a bit more consternation about the effects of federal tax law on its operations.

“Harborside Health Center currently employs approximately 80 individuals in Oakland, CA,” the letter reads. “Unless we can change this law, these jobs are in jeopardy.”

Clean and well lighted, Harborside has exploded in popularity with 58,000 members and regular media coverage. The dispensary brings in around $20 million in revenue each year, likely the most in the Bay Area.

The IRS audits large companies on a regular basis, but in looking at Harborside, DeAngelo believes the agency will be raising questions about a section of tax code known as 280e. The section, which was aimed at nabbing drug kingpins, prohibits companies from deducting any expenses if they are “trafficking in controlled substances.”

“Our contention is that what we’re doing is legal and not trafficking, and it’s not appropriate to apply it to us,” said DeAngelo. “This is an industry-wide issue.”

Bob McEligot, a partner at the San Francisco tax firm Calegari & Morris, explained that normal companies just pay tax on their profits after deducting expenses such as payroll and rent. But if the IRS found a medical pot dispensary to be trafficking in controlled substances, then “they would be paying on their gross income with no deductions at all,” said McEligot.

The difference could be enormous. A company the size of Harborside could be paying taxes at a rate of about 35 percent without being allowed to deduct expenses.

Luigi Zamorra, chief financial officer at Harborside, said that tax code section 280e is antiquated and should be changed to account for the new medical marijuana industry.

“This law was enacted a long time ago before there was a medical cannabis industry, and it was written as a back door punishment for thug-like drug dealers,” said Zamarra. “We would like a full exemption.”

Zamarra has come up with a method of accounting that allows Harborside to deduct almost all its expenses except for cost of the actual transaction in which money is exchanged for marijuana. It’s detailed in an article entitled “Medical Cannabis Dispensaries: Minimizing the Cost of IRC Section 280E.”

The seminal tax case on the issue was Californians Helping to Alleviate Medical Problems Inc. v. Commissioner of Internal Revenue, in which a judge ruled in 2007 that a pot dispensary could deduct expenses from all of its other activities apart from buying and selling marijuana, such as care-giving, yoga classes, rent and the like. You can read the opinion here.

Zamarra acknowledged that his accounting methods push the envelope beyond that case. “I anticipate a long road before an agreement is reached,” with the IRS, he said.