Taxable Talk

One of the blogs I read, How Appealing, posted a link to this story on California’s attempt to ban video games featuring “murder and mayhem” from being sold to children cost the Bronze Golden State $2 million.

That’s nothing.

There’s a case that’s still waiting to be heard at the Nevada Supreme Court that’s cost California taxpayers many millions, and has the potential to cost the state over half a billion (yes, $500,000,000). The Franchise Tax Board’s appeal of Gilbert Hyatt’s lawsuit is waiting a date to be set for oral argument. It’s been stuck in this status for over a year (the last change noted in the online tracking system for the case was on February 4, 2011). I don’t know what the average wait time is, but most likely later this year this case will be heard.

If the appeal is heard here in Las Vegas (the Nevada Supreme Court holds sessions in Carson City and Las Vegas), I plan on attending…some day (hopefully in 2012).

The Franchise Tax Board’s battle against Gilbert Hyatt continues in Las Vegas. Mr. Hyatt, as you may recall, moved from California to Las Vegas in the early 1990s a few months before he received a patent settlement in the millions. The FTB conducted a residency audit and found he was still a resident of Nevada. Mr. Hyatt sued the FTB in Nevada; the FTB fought the lawsuit claiming immunity from being sued. That case went all the way to the US Supreme Court, and the Court ruled that the FTB could be sued.

Last year Mr. Hyatt finally won his case, and he won big. He won $396.08 million. Over the last week Judge Jessie Walsh denied the FTB’s motion for a new trial. She also told the FTB that they must post a bond if they wish to appeal. Somehow, Judge Walsh doesn’t think California’s credit is good. I believe (but am not certain) that a 10% bond must be posted, so that would mean about $39 million.

What is thoroughly annoying to me is that the tactics that a California resident cannot sue the FTB even if the FTB were to use the same tactics as they used against Mr. Hyatt. The FTB does enjoy sovereign immunity in California.

Further motions are scheduled to be heard on March 11th. Presumably if these motions are denied the next step is for the FTB to file an appeal.

The Las Vegas Review-Journal has published an excellent summary of the Gilbert Hyatt case and judgments.

Mark Hutchison, Mr. Hyatt’s lead attorney, believes that the Franchise Tax Board will appeal the case. (I agree with him that the case will be appealed.) He’s quoted by the Review-Journal,

[The verdict] sends a clear message that government abuse and over-reaching will not be tolerated by Nevada citizens…I think the message is: If you are going to audit Nevada residents, you had better do so in a fair and impartial manner and not be results-oriented in seeking to grab money from Nevada residents.

Mr. Hyatt was also interviewed by the Review-Journal, and noted that the FTB’s original claim against him (that he was a California resident beyond September 1991) will be reviewed by the California Board of Equalization within two years.

My thanks to reader Darren Hankel to alerting me to this article.

A Las Vegas jury told California’s Franchise Tax Board in no uncertain terms that the FTB’s conduct towards Gilbert Hyatt was reprehensible. I had speculated that the jury would award Mr. Hyatt $250 million in punitive damages; that was exactly how much he received.

Mr. Hyatt had accused the FTB of several torts, including invasion of privacy, outrageous conduct, abuse of process, fraud, and negligent misrepresentation. Earlier, the same jury had awarded $138.8 million in actual damages.

Bill Leonard, a member of California’s Board of Equalization, said that the FTB spent $8.8 million fighting this case to date. If we add that, the $138.8 million of actual damages awarded earlier, and the punitive damages, the total is $396.08 million. Meanwhile, California has yet to receive any of the $7.4 million it assessed Mr. Hyatt (which is now nearly $50 million including penalties and interest). Mr. Hyatt is still fighting that decision.

Interestingly I could only find one news report on this story (the Sacramento Bee story I’ve linked to)—a story that is perhaps one of the most significant tax stories of the year. Mr. Hyatt’s lead counsel, Mark Hutchison, told the Bee, “Government agencies should pause and reflect on the significance of this verdict.” Mr. Hyatt noted, “[I hope] this will prevent other taxpayers from going through the same nightmare that I have had to endure for over a decade.”

The Bee story quotes the FTB’s former lead auditor, Brian Toman: “As far as I know, and I’ve been around a long time, there has never been an award of tort damages against the Franchise Tax Board in any kind of audit.” Well, there’s a good reason for that—Californians cannot sue the FTB for tort damages. California law grants state agencies sovereign immunity from lawsuits such as Mr. Hyatt’s (§860.2 of the Government Code). As noted in my previous post, Mr. Hyatt was able to sue because the actions the FTB took occurred in Nevada.

I fully expect the FTB to appeal the decision though officially no decision has been made. Interest will accrue to Mr. Hyatt during any appeal, so the total could easily exceed half a billion dollars. In the meantime it will be interesting to see if the FTB auditors realize that there is a line that shouldn’t be crossed.

Back in October 1991 Gilbert Hyatt moved from California to Nevada. California’s Franchise Tax Board didn’t think he did, so they commenced a residency audit. California determined that Mr. Hyatt didn’t establish residency in Nevada until April 1992. Normally, six months wouldn’t be a big deal; however, Mr. Hyatt had invented a microprocessor and received a substantial amount of income during that time period. California assessed $49 million in taxes.

Mr. Hyatt fought the judgment through administrative appeals. He also wasn’t happy about the methods the FTB used to investigate him. Mr. Hyatt filed a lawsuit against the FTB in Nevada, alleging

…that [FTB] directed “numerous and continuous contacts … at Nevada” and committed several torts during the course of the audit, including invasion of privacy, outrageous conduct, abuse of process, fraud, and negligent misrepresentation.

The FTB fought the case, arguing that they were immune from being sued. (As an aside, had the actions that Mr. Hyatt alleged took place in California, the FTB would be immune.) The case went all the way to the US Supreme Court; the Court ruled unanimously that the FTB could be sued in Nevada. The case was remanded back to the Nevada District Court for trial.

The first phase of the trial ended last week, and the FTB suffered a ringing rebuke. According to Bill Leonard’s Leonard Letter, Mr. Hyatt prevailed on every claim and was awarded $137 million in damages plus $1.08 million in legal fees. The jury is now looking at potential punitive damages which could easily be another $400 million or so.

What did the FTB do? From the Leonard Letter:

Tax agents rummaged through his trash without warrants, visited business partners and doctors, and shared his Social Security Number and other personal information with the media. This is outrageous behavior and I call on the FTB to rein in their agents. What really galled me is the FTB testified in open court that this level of harassment was only a typical audit. If true, then the stormtroopers are alive and well at the FTB.

I have little to add to what Mr. Leonard stated. And he should know; Bill Leonard is an elected member of California’s Board of Equalization. The BOE hears administrative appeals on FTB cases after an individual (or organization) exhausts appeals at the FTB.

What’s the cost to California? To date, the FTB has spent $8.8 million fighting Mr. Hyatt. Add the $138.88 million that is now owed to Mr. Hyatt and the total is $146.08 million. If we add another $250 million for punitive damages the total is nearly $400 million. And while Mr. Leonard is hopeful that the FTB won’t appeal the case, I am almost 100% certain that the FTB will appeal. Thus, unless the FTB gets lucky in Nevada this case could easily cost California taxpayers over half a billion dollars.

Welcome to the Bronze Golden State….