Smoke Shop Shocker: New York City fighting to collect taxes on cigarettes sold on Indian reservation

After doing time for possession and an accidental killing, crack dealer Rodney Morrison decided that he was finished with drugs. He threw himself a "retirement" party in 1993 and got into a new line of work: tax-free cigarettes. It was a business operating in a gray area of the law, and the riches were enormous.

Within 10 years, the smoke shop that Morrison opened on Long Island's little Poospatuck Indian Reservation had become one of the state's biggest dealers in untaxed cigarettes. Other drug dealers soon took note and followed him into the business.

By 2007, one in every seven packs sold in New York state came from either Morrison's shop or three others on the reservation, all four managed by people with a history of drug dealing, The Associated Press found in a review of court and business records. Those four stores sold 9.9 million cartons of cigarettes that year, or enough to supply every smoker in New York City with a pack a day for 3½ months.

Now, it may all be going up in smoke for the cigarette kingpins of the Poospatuck reservation.

Dismayed by the lost tax revenue, New York City has waged a legal battle that could put such shops as Morrison's out of business. This month, Poospatuck stores may have to begin collecting taxes for the first time because of a federal judge's ruling that untaxed sales to non-Indians are illegal.

Morrison, 42, is in deeper trouble. He could get up to 30 years in prison when he is sentenced Sept. 25 in a case in which federal prosecutors set out to blame him for a murder but wound up convicting him of illegally trafficking in cigarettes.

Other states have also struggled with the sale of untaxed cigarettes at reservation smoke shops, and federal prosecutors have filed smuggling charges in recent years against a few dealers in Idaho and Washington state. But the cigarette trade on New York's reservations dwarfs the business in other states, with 304 million packs sold in 2007 alone.

The Poospatuck case is being watched closely. If the court decisions are applied to all reservation smoke shops statewide, they could doom a $6 billion-a-year business in Indian tobacco that now accounts for a third of New York's cigarette sales.

The Poospatuck reservation, the preserve of the Unkechaug tribe, is in the town of Mastic, about 60 miles from New York City. Because the state doesn't collect sales taxes on Indian land, cigarettes bought there can cost less than half of what they do in New York City, which has the nation's highest tobacco taxes. In the city, a carton of Marlboros costs about $95, including $42.50 in state and local taxes.

As a result, "buttleggers" -- operating, investigators say, with the assistance of some store owners -- buy large quantities of cigarettes on the reservation and resell them in the city at a big markup.

"There's no difference between the cigarette business and the drug business. It's the same type of individuals involved," said Kyron Hodges, a former drug dealer who joined legions of street hustlers transporting tax-free cigarettes from the reservation to the city. "I took all of my street knowledge and applied it to cigarettes."

Technically, New York state law allows reservation merchants to sell tax-free tobacco only to members of the tribe for their personal consumption.

But until now, the rule has never been enforced against the smoke shops themselves, despite the loss of more than $700 million a year in state and local tax revenue. Since the mid-1990s, New York governors fearful of stirring up tribal unrest have instructed state tax officials to leave the smoke shops alone.

And so, as state authorities looked the other way, Morrison's business boomed, grossing $172 million in one 4½-year period, according to bank records. He bought homes, land and businesses; stashed $30 million in foreign banks; and collected $1.7 million worth of luxury watches.

Morrison's attorney, Billy Murphy, said that his client's transformation from drug dealer to entrepreneur should be viewed as a success story. "Rodney decided to give it up and go legit," Murphy said.

Prosecutors, though, said that Morrison didn't change his methods. He kept a gun in his office. He talked tough. And when a wave of violence swept the reservation, people began pointing fingers.

The car of one smoke- shop owner was firebombed. Another shop owner was beaten and robbed. Armed men burst into a tribal-council meeting and threatened the chief's life. Then, in 2003, a rival cigarette dealer, 23-year-old Sherwin Henry, was shot to death.

Morrison was indicted on federal racketeering charges accusing him of Henry's murder and a string of other violent crimes. The jury acquitted Morrison last year on most counts, including the murder charge, but found him guilty of racketeering for selling untaxed cigarettes to non-Indians.

The verdict came as a shock to scores of reservation smoke shops across the state engaged in a nearly identical business.

Since the trial, state courts have continued to send conflicting messages about the smoke shops' legal obligations.

Things could come to a head in the next few weeks. In her Aug. 25 ruling in the city's lawsuit, Judge Carol Bagley Amon of U.S. District Court ordered the Poospatuck stores to start collecting taxes on sales to non-Indians in 30 days.