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San Diego auditing marijuana dispensaries as tax revenue starts to roll in

San Diego auditing marijuana dispensaries as tax revenue starts to roll in
Jay Frentsos shows various marijuana edibles sold at the Urbn Leaf marijuana dispensary in San Diego in 2017 (Hayne Palmour IV/San Diego Union-Tribune)

San Diego is trying to boost tax revenue from the city’s dozen legal marijuana dispensaries by auditing them and tightening restrictions on sales to medical cannabis patients, which are tax-exempt.

The audits, which are expected to conclude this month, aim to ensure the dispensaries are complying with a 5% tax on all cannabis sales that city voters approved in 2016, officials said.

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The tax, which will increase to 8% on July 1, is expected to generate more than $6 million in revenue for the city in the current budget year, officials said. It’s a gross receipts tax, so it covers all revenue generated by a marijuana business.

Another goal of the audits is revealing the names of distributors supplying marijuana and edible products to the dispensaries, helping the city ensure none of those businesses are skirting the cannabis tax.

The city treasurer also plans to begin forcing dispensaries to require medical cannabis customers to present a state-issued Medical Marijuana Identification Card in order to be exempt from the city’s cannabis tax.

Since the city tax took effect in January, medical cannabis customers have been able to avoid paying the city tax by simply showing dispensary employees a physician’s recommendation.

Owners of the city’s dispensaries, who lobby jointly through an organization called the United Medical Marijuana Coalition, have raised no objections to the audits.

"Our organization supports this, and our members volunteered to be audited to ensure they were accounting for and remitting taxes properly because they want to avoid mistakes that would amount to costly surprises if discovered later," said coalition spokeswoman Rachel Laing.

While some dispensaries may have made honest mistakes in calculating the taxes they owe the city, Laing said the audits should not be characterized as a crackdown.

“The audits are less about suspicions by the city that dispensaries are noncompliant, and more about the city wanting to understand and be reassured they’re collecting adequately,” she said. “It’s in dispensaries’ best interest that they ensure they’re remitting properly and correct any mistakes early.”

Jessica McElfresh, an attorney who represents multiple dispensaries, agreed with Laing and said the city’s efforts have been nothing like a stereotypical audit by the Internal Revenue Service.

"It was more like a general checkup," McElfresh said. "Licensed businesses are audited. I haven't heard a lot of complaining."

McElfresh, however, said she has some concerns about the new verification requirements for medical cannabis customers.

First, she questioned whether the city can legally begin requiring the state identification cards when the city’s cannabis tax initiative, Measure N, said medical sales were exempt and didn’t specify how that would be verified.

"It doesn't say someone needs to have a medical identification card to be exempt from this tax," said McElfresh, adding that she’s unsure how the measure could be amended. "It may be something the City Council can do, but I think they may have to go back to the ballot box."

McElfresh also said tighter restrictions will be a burden on medical cannabis patients, estimating that only about 10% have state identification cards.

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The cards, which are issued by county officials, cost $100 per year and typically require medical cannabis users to spend several hours at a county facility, she said.

Laing, the dispensary coalition spokeswoman, estimated that 20% of customers at the city’s legal dispensaries declare themselves medical patients and don’t pay taxes.

While 19 dispensaries have received city approval to open, only 13 have actually begun operations. The audit covered 12 of those.

The audit and tougher restriction on medical sales come just before revenue from the city cannabis tax is expected to sharply increase thanks to the opening soon of 40 marijuana production facilities – indoor pot farms and edible factories.

The city agreed last year to allow 40 such business to open in San Diego to create a local supply chain for the dispensaries, and more than two dozen have gotten through the city’s lengthy approval process this fall.

The city collected $2.7 million in cannabis tax revenue between January and June. But officials said they expect revenue to climb well above $6 million in the current budget year ending June 30.

The increase is expected because additional dispensaries and the first wave of marijuana production facilities are due to open, and because of the audit and tougher restrictions on medical sales.

Business has sharply increased at the city’s legal dispensaries since the state began in January to allow sales of recreational marijuana, which California voters approved in December 2016.

In addition to paying the city’s cannabis tax, dispensaries must collect state sales tax from recreational marijuana customers. Medical cannabis customers with a state identification card don’t have to pay the sales tax.

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