OAKLAND (CBS 5) – The Internal Revenue Service has ordered an Oakland medical marijuana dispensary to pay millions in back taxes. Advocates fear the decision could deal a serious blow to the industry.

“The IRS has given us a tax bill of $2.5 million,” said Steve DeAngelo, executive director of Harborside Health Center.

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The Internal Revenue Service launched a two-year audit of Harborside, under a specialized tax code called 280-E. It intended to stop wholesale drug dealers from legally deducting business expenses while selling illegal drugs.

DeAngelo said, “The IRS is claiming we are a drug trafficking organization.”

But Harborside is licensed and pays taxes in the city of Oakland. In fact, the dispensary is in the top 10 of city taxpayers.

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Recently, Oakland announced plans for expanding the medical marijuana industry, hoping to capitalize on increased tax revenue. But the tax code denies pot clubs from taking standard business deductions for rent, payroll and health insurance, because federal law classifies marijuana as illegal.

“We will be taxed out of existence,” De Angelo said.

Despite the tax code, Harborside can deduct certain expenses. “This is the crazy part of it,” DeAngelo said. “The IRS is allowing us to deduct all of the money that we paid to purchase the cannabis itself. But will not allow us to deduct things like our payroll.”

DeAngelo told CBS 5 the dispensary intends to fight the tax bill in court.

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