The Internal Revenue Service has ordered Oakland's Harborside Health Center, the largest medical cannabis dispensary on the West Coast, to pay $2 million in taxes after ruling that the collective cannot deduct standard business expenses, such as payroll and rent.

The decision has alarmed the operators and added frustration over the tightening of federal policies governing medicinal cannabis.

"They're attempting to tax us out of business," Harborside owner Steve DeAngelo said Tuesday by telephone.

Ironically on the same day he received the IRS letter, DeAngelo was photographed handing the city treasury a check for $360,000. The payment was the third installment of $1 million in city-owed taxes generated by the dispensary in 2010. Oakland's four dispensaries pay a 5 percent tax to Oakland on top of regular sales taxes that contributed about $2 million to California's budget.

That is money Oakland and the state cannot afford to lose, DeAngelo said.

"It's not just Harborside that's under threat here."

Harborside's audit began two years ago and covered 2007 and 2008 tax filings.

The dispensary paid the IRS a total of $500,000 in those years, and the IRS did not dispute Harborside's record keeping. The agency did deny $2 million in deductions the dispensary took during both years for, among other things, security, lab testing, licensing fees and employee health insurance. Harborside must also pay a penalty of nearly $400,000, DeAngelo said.

The agency based the decision on the fact that Harborside provides medical cannabis, a substance that while permitted in California is still illegal under federal laws.


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The IRS ruling further complicates Oakland's pursuit of more tax dollars from large-scale marijuana cultivation for medicinal purposes. It also has DeAngelo worried about the future of his dispensary, which opened in 2007. Harborside might not be around to pay next year's taxes if the federal government continues to tighten the noose around the medicinal cannabis industry, he said.

The IRS is auditing more than a dozen other dispensaries in California, and banks are refusing to do business with dispensaries for fear federal regulators will prosecute them.

The policy is not new but fear has increased in the industry since a recent U.S. Department of Justice letter stated the agency is committed to enforcing federal drug laws.

The East West Bank closed Harborside's account three weeks ago, according to DeAngelo. A bank representative and the U.S. Treasury Department could not be reached for comment. IRS spokesman Jesse Weller said the IRS cannot comment on the case because of privacy and disclosure laws.