$396.08 Million…and the Meter Is Still Running

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

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

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

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

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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A Very Unlucky Spendthrift Lottery Winner

If you are lucky enough to win the lottery definitely plan on paying your taxes. Indeed, you’ll find that the government will be quite helpful in that regard, and that taxes will be withheld from your winnings.

Do remember, though, that even after your lottery winnings cease coming in that you’ll have to pay taxes. One Florida woman didn’t, and she’ll be spending two years at ClubFed because of that.

Rhoda Toth and her late husband won $13 million in the Florida lottery. She and her husband spent it all and then some, and had to declare bankruptcy. They also filed a false tax return. Eventually she and her husband were indicted on various federal tax charges. Her husband passed away before the trial began. Ms. Toth pleaded guilty, and asked to be spared from going to ClubFed because of bad health—she suffers from multiple sclerosis.

The IRS thought she wasn’t in as bad health as she said. And they videotaped her walking without help of crutches or a walker. So instead of no jail time the judge elected to send her away for two years.

This is a sad story, and brings up a point that we should all remember: whatever you earn, spend less and save some money for a rainy day.

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Troutman Pleads Guilty

When I was growing up just north of Chicago my parents told me about how the dead voted. That didn’t seem right to me, but I did learn at a young age about Chicago politics.

Last year I reported that former Alderman Arenda Troutman was accused of 13 counts, including mail fraud and tax fraud. She had said she was innocent…until this week.

Sam Adam, Jr., Troutman’s attorney, told the Chicago Defender, “I can say that the federal government did their homework, which is evident by what we see here today. For the benefit of her family and for the benefit of her personally, we felt this was the best thing to do at this time.” What she did was to plead guilty to one count each of mail fraud and tax fraud.

When she’s sentenced this December she’ll be spending some time at ClubFed. Her attorney is hoping to keep the sentence under 33 months; however, she’s likely to spend around four years there.

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Snipes’ Bill: $217,363.75

Wesley Snipes recently got clearance to go overseas to film a movie while waiting for his appeal to be heard. It looks like he’ll need some of the money he’s making: he just received the bill for his trial.

As Kay Bell reported in Don’t Mess With Taxes, Mr. Snipes has been ordered to pay $217,363.75. That represents $2,456.40 for trial transcripts, $138.18 for certifying and copying exhibits, $21,052.19 for witnesses, and $193,716.98 for scanning, printing and numbering documents.

Going to court can be expensive….

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Another Week, No Budget

No surprise, really, that California still has no budget and frankly there’s been no progress. Democrats want to increase taxes, Republicans don’t, and neither side is talking to the other.

Yes, things are normal in Sacramento….

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Midweek Evasion

It’s only my third day back from vacation. Some of the individuals mentioned below will be counting the days at ClubFed very soon.

Let’s start in Stillwater, Minnesota. Randy Haugen owned an automobile repair business, and it was apparently quite successful. One of his methods of improving his bottom line was allegedly not remitting sales tax to Minnesota and not filing income tax returns. Those methods really do help the bottom line…until you’re caught. The Minnesota Department of Revenue said that Mr. Haugen, “knew this day was going to come and he dreaded it.” As a helpful hint, if you find yourself in that situation get an attorney and make a payment plan rather than postponing the inevitable discovery of the tax evasion.

Staying in the Twin Cities, a former co-owner of a roofing business is accused of conspiracy, mail fraud, tax evasion, and filing false tax returns. Amit Sela of Minnetonka, Minnesota, allegedly embezzled over $600,000 from Sela Roofing, and then allegedly filed false tax returns to cover up the theft. On the other hand, Mr. Sela’s attorney, Eric Brever, told the Minneapolis Star-Tribune, “We believe a jury will find Mr. Sela innocent of all the charges…[A]ll of the taxes were paid prior to the IRS criminal investigation.” That’s a big difference of opinion and we won’t know the answer until the case comes to trial.

Finally, from Grand Rapids, Michigan, we learn that two former executives of U.S. Signal, a telecommunications firm serving the Great Lakes region, are pleading guilty to tax and mail fraud charges. The two, Barry Raternik, the former president of U.S. Signal, and Tim Hall, who used to be the company’s director of operations, teamed with a supplier, Douglas Lautenbach (who also pleaded guilty) to overcharge the company for fiber optics. The three pocketed the difference and used the ill-gotten gains to fund lavish homes, sports cars, RVs, and other expensive items. They also allegedly sold other equipment on the secondary market. Instead of enjoying the luxury items they’ll likely get to spend a few years enjoying the not so luxurious insides of various ClubFed facilities.

In the end, most of these “perfect crimes” end up with the same result—the participants enjoying ClubFed and making restitution to the government. Crime just rarely pays.

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