Tax loophole puts heat on cheap-cig shops

There is no place in the United States more expensive to smoke than New York City, where the taxes alone will set you back $5.85 per pack. Yet, those who visit Island Smokes, a "roll-your-own" cigarette shop in Chinatown, can walk out with an entire 10-pack carton for under $40, thanks to a yawning tax loophole that officials in several states are now trying to close.

The store is one of a growing number around the country that have come under fire over their use of high-speed cigarette rolling machines that function as miniature factories, and can package loose tobacco and rolling papers into neatly formed cigarettes, sometimes in just a few minutes.

The secret to Island's low prices is simple: Even though patrons leave carrying cartons that look very much like Marlboros or Newports, the store charges taxes at the rate set for loose tobacco, which is just a fraction of what is charged for a commercially made pack.

Customers select a blend of tobacco leaves, intended to mirror the flavor of their regular brand. Then they feed the tobacco and some paper tubes into the machines, and return to the counter with the finished product to ring up the purchase.

The savings come at every level. Many stores sell customers loose pipe tobacco, which is taxed by the federal government at $2.80 per pound, compared with $25 per pound for tobacco made for cigarettes. The shops don't pay into the cigarette manufacturer trust fund, intended to reimburse government health programs for the cost of treating smoking-related illness.

And the packs produced by "roll-your-own" shops are generally also being sold without local tax stamps, which in New York include a $1.50 city tax and a $4.35 state tax.

New York City's legal department filed a lawsuit against Island Smokes on Nov. 14, arguing that the company's Manhattan store and another on Staten Island are engaging in blatant tax evasion.

Every package of cigarettes sold in the state, the suit argued, must bear a New York tax stamp.

Businesses that sell unstamped cigarettes are violating both local law and the federal Contraband Cigarette Trafficking Act, city lawyers said.

The suit, filed in federal court in Manhattan, also accused the store of violating a state law requiring cigarettes to meet fire safety standards.

"By selling illegally low-priced cigarettes, defendants not only interfere with the collection of city cigarette taxes, they also impair the city's smoking cessation programs and impair individual efforts at smoking reduction, thereby imposing higher health care costs on the city and injuring public health," the complaint said.

Mayor Michael Bloom-berg, who has advocated for aggressive legal action against cigarette sellers who avoid taxes, was to announce the lawsuit at a news conference Monday.

A pack contains 20 cigarettes and sells for about $13 in New York City after taxes are added. That compares with the national average in 2010 of $4.80 a pack, according to the Centers for Disease Control and Prevention.

A pack from Island Smokes can cost less than $4 a pack.