Two From the Not Safe for Work Profession

Posted on August 24, 2008 by Russ

I’ve written in the past that there’s something about Escort Services that somehow get their owners in tax trouble. Late last week two other individuals in related industries pleaded guilty to tax evasion charges.

First, from Eugene, Oregon, comes the story of Janine James. Ms. James, also known as Janine Lindemulder, hails from nearby Huntington Beach. Ms. James has appeared in numerous adult films and adult magazines such as Penthouse. Unfortunately for her, she decided that making a down-payment on a new home in Eugene was more important than paying the IRS. The IRS begged to differ, and she pleaded guilty to intentionally failing to pay her income taxes. She’ll be sentenced later this year, and will likely need to make restitution and could end up making a short stay at ClubFed.

Meanwhile, in Charlotte, North Carolina, there was a rather high-end prostitution ring called Soft Touch Industries run by husband and wife Donald & Sallie Saxon. This wasn’t a small-time ring; revenues were estimated by prosecutors to be around $3 million. Earlier this year a Raleigh cardiologist was charged in the case. On Thursday another individual pleaded guilty. James Smith, owner of Red Clay Industries, used the escort service’s services. However, he decided to charge the expenses to Soft Touch Industries as business expenses. What Soft Touch provided were definitely personal in nature….In any case, Mr. Smith has pleaded guilty to tax evasion and is cooperating with federal prosecutors. He’ll pay $19,000 in back taxes and prosecutors will ask for a light sentence.

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Good Summary of Hyatt Case

Posted on August 20, 2008 by Russ

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.

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This Week for the Budget? I Don’t Think So

Posted on August 19, 2008 by Russ

California Assembly Speaker Karen Bass told the Wall Street Journal that she expects to reach a budget compromise this week. I doubt it.

The Democrats are still only arguing to increase taxes. Republicans in the Legislature vow that’s not going to happen. Democrats, including Speaker Bass, say that there’s no spending left to cut because of previous cuts; Republicans say that there’s plenty left to cut and that the Legislature needs to implement permanent spending restrictions.

Does that sound like there’s a compromise that’s imminent?

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Takeout Is Taxable

Posted on August 19, 2008 by Russ

That seems obvious, right? You need to charge sales tax on items that are picked up.

Hopefully it also seems obvious that if you’re a liquor store owner you need to include takeout items in your income. There’s no exemption for takeout items in the Tax Code…but you knew that.

Well, you know that, I know that, but one carryout (liquor store) owner in Toledo, Ohio apparently didn’t know that. Ann Riebe pleaded guilty to one count of Conspiracy to Defrauding the United States. Riebe and another owner took cash that customers paid and allegedly took some of that home with them, or wrote checks and didn’t declare the income. Riebe will only serve one day at ClubFed but will spend ten months under house arrest and will have to make restitution with the IRS.

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10 Years, 2 Cars, 4 Pieces of Property, and $2.7 Million

Posted on August 17, 2008 by Russ

Earlier this year I posted about a complex tax fraud case out of Salt Lake City. Several individuals were accused of helping various other individuals and businesses evade about $20 million in taxes. Three pleaded guilty. One of those who chose to go to trial (and was found guilty), Sandy, Utah attorney Dennis Evanson found out his fate on Friday. The judge sentenced him to 10 years at ClubFed, and he must forfeit his Hummer, Toyota Tundra, four pieces of property, and pay $2.7 million in fines. Mr. Evanson had been found guilty of mail fraud, wire fraud, tax evasion, and assisting in preparation of false tax returns.

The scheme the conspirators used had the usual trappings: foreign entities (in this case, on the Cayman Islands), foreign bank accounts, and fraudulent transactions. During the trial testimony revealed that the conspirators kept 30% of the tax saved.

If you happen to have utilized the services of Mr. Evanson or one of his co-conspirators, you will likely receive a “Dear Valued Taxpayer” letter from the IRS. It appears that the tax you “saved” is more like a mirage.

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$396.08 Million…and the Meter Is Still Running

Posted on August 17, 2008 by Russ

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.

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Even Pot Growers Need to Pay their Taxes

Posted on August 13, 2008 by Russ

Medical marijuana is a complex subject. California voters passed an initiative legalizing it; the federal government says its still illegal under federal law. I’ll let the attorneys battle that one out.

However, whether medical marijuana is legal or illegal doesn’t impact the tax situation for a grower. Illegal income is just as taxable in the United States and California as legal income. And that’s where our story begins.

Edwin Hoey pleaded no contest last year to possessing and selling “hundreds of pounds of pot.” He has now been arrested on five charges of filing a false state income tax return.

Mr. Hoey’s attorney, Ben Rice, is quoted by the Central Coast Sentinel, as stating, “This gray area is very gray, very dark and it’s hard for people who want to do this exactly the way they’re supposed to…It’s hard for people to know how to do it… Hoey has paid his taxes and he’s prepared to rectify his tax statements but it’s really difficult to know how to do that.”

I hate to tell Mr. Rice, but I think he’s very wrong here. Mr. Hoey was conducting a business. It’s pretty simple: add up all your income, subtract your expenses, and you’ve got your net income. Perhaps it was hard for Mr. Hoey to include his illegal income on his tax return but it’s the law.

Mr. Rice also complained that the government is getting a second bite at the apple. But tax charges are different from drug charges—it’s not double jeopardy.

And I have even more bad news for Mr. Rice and Mr. Hoey. It’s quite possible that the IRS will take a look at this case, too. The IRS and the Franchise Tax Board (California’s state income tax agency) share information.

So if you decide to get in a business that’s in a gray area (or even one that’s over the line) do make sure to file and pay your taxes.

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An Aphrodite Falls

Posted on August 13, 2008 by Russ

It must be something about the profession. Yet another Escort Service owner is in trouble over taxes. Theresa Faye Hope pleaded guilty to tax fraud charges today. Ms. Hope was the proprietor of Aphrodite Inc., a subchapter S Corporation. There’s nothing wrong with that.

Of course, understating her company’s income by $267,000 wasn’t acceptable. True, that didn’t change her corporate tax at all (S Corporations are “flow through” entities; the owners pay the tax). However, it did result in her underpaying her federal income tax by over $50,000. That results in up to three years at ClubFed, a fine of up to $250,000, and possible restitution.

The article notes that her service charged only $125 for a half hour or $175 for an hour, and that she kept just $50 or $75, respectively. While she apparently did listen to her accountant and set up an S-Corp, she missed her accountant telling her to always put aside enough money to pay your taxes.

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$146.88 Million and Counting

Posted on August 11, 2008 by Russ

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….

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A CFO and a CEO Find their Fates

Posted on August 10, 2008 by Russ

Two business executives. Two men with tax troubles. Is ClubFed in their futures?

Joseph Smith was the former treasurer and CFO of the Catholic diocese of Cleveland, Ohio. He supplemented his earnings by engaging in a kickback scheme. He funneled work to a co-conspirator and in return received kickbacks of over $784,000. And those kickbacks were disguised as compensation for consulting and legal services. He was found guilty of six tax charges and will be sentenced this October.

Lyle Larson was a not-so-successful computer entrepreneur in Edmonds, Washington. His tax return showed that he only made $38,000 of business income. That is, when he bothered to file a tax return (he “forgot” in 2004, 2005, and 2007). I did leave some things out. Like his luxury yacht. His cars. His $2.8 million in earnings. Mr. Larson left those out from his tax returns between 2000 and 2003. He’ll have 18 months at ClubFed to think over those omissions, and he must make restitution of over $879,000 to the IRS.

If you get lucky in business or otherwise do yourself a favor. Set aside some of your earnings to pay your taxes. You can pay now, or pay later, but it’s a whole lot easier to pay now.

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