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Dave Armstrong spent his past professional life chasing scofflaws as a bail bondsman in Boise, Idaho. When Aladdin Bail Bonds bought his firm, he took a few years off to retire, travel and enjoy the financial windfall. Until he got bored. When President Obama talked after his 2008 victory about giving cannabis collectives a pass under federal law provided they followed state rules, it sounded, to him, like a call to action.

"I thought, 'I can follow laws, that's what I do,'" Armstrong says. "So I packed all my stuff and moved out to California."

At first, he planned to spend a few years learning to cultivate marijuana up north in the Emerald Triangle. But a real estate agent approached him with an offer he couldn't pass up: to take over a lease on a single-story collective in an industrial quarter of San Jose.

"I hauled buns down here, met with the owner and shook hands on the spot," says Armstrong, 47, a corpulent Midwesterner and (formerly) staunch Republican who's still mildly surprised that he wound up in California, let alone in the pot club business. Keeping in mind the California Attorney General's newly released guidelines to keep the feds off his back, he set up the new venture, MediMarts, as a closed-loop dispensary. No vendors, no transactions, no sales, a short trip from plant to patient. An indoor grow lies behind the club on Little Orchard Avenue, near corporate offices and industrial buildings. Another football field-sized crop sprouts in the sun on an acre of leased land in Morgan Hill. Edibles are cooked up in an adjacent former cake bakery.

"A true collective," Armstrong likes to boast. Revenue comes in through membership fees, called "equitable contributions" on receipts. Every member becomes a part owner.

The operation has lasted upward of four years, through San Jose's failed attempt in 2011 to regulate dispensaries. Just before the city enacted a new medical marijuana ordinance over the summer that put in place strict zoning and operations requirements, a TV reporter stopped by his South County grow, where Armstrong declared his a model dispensary.

"They're an example of what you can do if you want to comply," agreed Mayor Chuck Reed in an interview with CBS Channel 5 news, referring to the city's new regulations. "It can be done." Maybe the mayor spoke too soon, or had his fingers crossed. Armstrong, the self-proclaimed "golden child" of San Jose collectives finds himself on the receiving end of a lawsuit by the city that aims to shut down MediMarts. While apparently complying with the spirit of San Jose's nascent regulations, he fell $770,000 behind on the local marijuana business tax, passed by 78 percent of voters in 2010, landing him on the short list for closure.

Now, Armstrong has to explain before a judge how he's avoided the sales tax because he sees it as an admission of profiting from a controlled substanceóillegal under federal law. As a salaried agent of the collective, he willingly pays income tax and wouldn't mind paying a city tax if they called it anything but an assent of sales. "Call it an enforcement fee or a permitting feeójust not a sales tax," he says.

Armstrong has enlisted a formidable ally in Bill Panzer, a drug defense attorney who helped draft Prop. 215óthe "Compassionate Use Act," which made medical marijuana legal in California in 1996. Together, they hope to challenge the city in court and, possibly, if it goes it goes to a higher court, set a precedent framing the business tax as a violation of federal law. "The whole issue with David's situation is that [San Jose's] ordinance basically says you're required to engage in sales to comply," Panzer says. "But if you have a truly socialist collective, which is perfectly legal under state law, there's no exchange of ownership, no sales. Yet San Jose lawyers are saying you can't do it that way."

Armstrong has a separate case pending against the IRS and state Board of Equalization, challenging a section of the federal tax code that prevents marijuana businesses from writing off any expenses. Section 280E of the federal tax code denies tax credits and exemptions to organizations "trafficking" in controlled substances, which drives dispensary tax rates up to 60 to 90 percent. Industry analysts call the 1982 tax code amendment a sneaky way of enforcing Reagan-era war on drugs.

"This year is going to be a wonderful year," Armstrong says sarcastically. "I get to educate the IRS, educate the state and educate the city all over again. Meanwhile, legislators are going to put something together and they don't know what the fuck is going on."

Armstrong's case underscores the uncertainty of the marijuana market as San Jose stumbles forward with new regulations while California, which once led the way in allowing medical marijuana, lags behind other states in legalizing its recreational use. San Jose's new rules also have the effect of challenging the most dominant business structure of the marijuana industry: the retail-vendor model, where outside growers sell medicine to a pot store for re-sale, often shopping around for a club to take it off their hands. It's unclear at this point how many collectives will be able to make that switch.

"That's the green elephant in the room," says Amstrong, who used to advertise MediMarts as the only closed-loop collective in town, which set off a flurry of disdainful gossip among other dispensary owners, most of whom rely on vendors to supply medicine, a wholesale-to-retail set-up.

The next 18 months will be a test and a waiting game. A test for San Jose and its collectives transitioning from legal limbo to regulation. A waiting game for the broader industry to see if the state could come up with guidelines in the next few years that fill yawning regulatory gaps that expose the industry to enormous liability and perpetuate a massive underground economy... continue reading