Dispensaries: Health Centers or Drug Sellers?

As money flows, medical marijuana providers face scrutiny from police and the IRS

Medical marijuana dispensaries try hard to maintain the appearance that they are nonprofit health centers. Customers are referred to as “patients,” and merchandise as “medicine.” Yoga classes are often available, along with health-related literature.

But the rivers of cash flowing in and out of these businesses are attracting scrutiny from local and federal authorities who say they are trying to distinguish between legitimate health practitioners and sellers of illegal drugs.

“We’re trying to get to a point where we get we can weed out – for lack of a better word – to filter out the people that are really perverting this law just to sell drugs,” said Frank Carrubba, deputy district attorney in Santa Clara County.

Last month, the four operators of New Age Healing Collective in San Jose were charged with illegal marijuana sales and money laundering after the police said they turned up two sets of books. The raid was part of a series of recent investigations into San Jose dispensaries by the Santa Clara Special Enforcement Team.

One ledger, kept at the tiny dispensary, showed New Age Healing losing $123,128 since May, according to the police. Another, which the police said had been discovered inside a cash-filled shoe box in the home of the couple that operated the center, told a different story: $222,238 in profits.

The couple said it was operating a legitimate marijuana dispensary and had done nothing wrong, according to one of their lawyers.

In Oakland, Harborside Health Center, one of the largest dispensaries on the West Coast and a model for the medical marijuana industry, is being audited by the Internal Revenue Service, said Harborside’s chief executive, Stephen DeAngelo. An IRS spokesman said the agency neither confirmed nor denied audits.

Last month, officials in Oakland postponed plans to license large-scale marijuana farms in the city after the Justice Department and the city attorney warned separately that the businesses could violate state and federal marijuana laws.

The medical marijuana industry has continued to flourish since a state proposition to legalize cannabis was defeated in November. Oakland finance officials estimate that the city’s three dispensaries generated $35 million to $38 million in revenue last year, up from $28 million in 2009.

San Jose now boasts 98 dispensaries – four times the number of 7-Eleven convenience stories in the city.

State law allows collectives to cultivate medical marijuana, but the law is less clear when it comes to selling the product, said William Panzer, a lawyer who helped write California’s seminal medical marijuana law, Proposition 215. Under guidelines issued by the state attorney general, dispensaries are advised not to profit from their activities. But the guidelines are fuzzy, Panzer said, and there is virtually no case law on the issue.

“Let’s come out from under the shadows and say, ‘Here are the rules,’” Panzer said. “The law around distribution is very hazy, and we need the Legislature to do something. We’ve fallen behind other states on regulations for medical marijuana sales.”

After staking out the New Age Healing Collective for eight months, Santa Clara County narcotics agents raided it on Oct. 7. They found marijuana and a black ledger listing sales and expenses, a police report said. The ledger stated that the collective’s $255,642 in sales from May through September were offset by $323,170 in operating expenses and $55,600 that the dispensary spent on rent and payroll.

The same day, officers raided the home of Jonathan Mitchell and Sheresie Dyer, the operators of New Age Healing. In a clothes closet, according to the police report, they found a Glock pistol, a pound of marijuana and a shoe box containing $15,971 and a “cash book.” The ledger, the report stated, showed that New Age’s gross receipts were $601,008 for those five months, a $222,238 profit.

“Their described activity as a collective is nothing more than a retail store,” wrote Sgt. Dean Ackemann, who is now with the San Jose district attorney’s office. “Their only actions are providing marijuana to customers at street-level prices.”

The police say they also found state tax returns, listing $84,111 in gross sales for the second quarter of 2010, which the report characterized as “highly suspect.”

Geoffrey Rawlings, Mitchell’s lawyer, said that he would not comment on the specifics of the case, but that his client was legally providing medical marijuana to patients. Mitchell and the others have all pleaded not guilty.

Rawlings noted that the police were not raiding pizza restaurants, which are also cash businesses, but that the profile of marijuana dispensary operators might play a role in attracting the attention of the authorities.

“When you’re dealing with medical cannabis and you see these blond, dreadlocked corporate officers coming and going, it kind of agitates law enforcement and raises their hackles a little more than the pizza shop owner down the street,” Rawlings said. “They are convinced that these people are breaking the laws without any evidence in advance that they’re breaking the law.”

Medical marijuana activists have loudly protested the raids on San Jose dispensaries, which have proliferated without any city regulations.

“We are extremely concerned by the raids,” said Paul Stewart, executive director of the Medicinal Cannabis Collective Coalition, which represents several San Jose dispensaries. “They are acting on what could be considered a specious legal finding by the DA; their finding is that all collectives are operating illegally because they are making a profit.”

Stewart said the dispensaries were easy targets since they were out in the open, unlike methamphetamine labs or other illicit drug operations.

“There is a concern that it appears they are attacking the low-hanging fruit,” he said.

Because laws are murky, dispensaries increasingly operate in the gray area between large-scale businesses and nonprofit health centers.

“It’s almost a hybrid operation,” said Betty Yee, the Bay Area’s representative on the Board of Equalization, which oversees state taxes. “It’s kind of difficult line to straddle for them, but a lot of them are doing it.”

Yee also said that although money was pouring into dispensaries, that did not mean operators were making big profits.

“The cost of their product is so huge that there is sometimes a perception that they’re making a lot of money when in fact their margins are pretty thin,” she said.

Though federal authorities have halted raids on medical marijuana dispensaries under the Obama administration, the IRS has shown a new interest.

Harborside officials said the IRS was raising questions about a section of the tax code known as 280E. That section, aimed at drug kingpins, prohibits companies from deducting any expenses if they are “trafficking in controlled substances.”

Harborside, which serves 70,000 members, has been lobbying the federal government to exempt medical marijuana dispensaries from the law. It sent a letter to Senator Barbara Boxer, Democrat of California, stating that it could be taxed out of business if the law was not changed.

“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.”

DeAngelo, the Harborside chief executive, said that all the profits were put back into the business – and that the dispensary was not a drug dealer.

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