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After over twenty years of litigation, California Franchise Tax Bd. v. Hyatt recently made its second appearance before the U.S. Supreme Court. In this interview, Bradley Marsh, a tax attorney with Greenberg Traurig LLP, discusses the impact of this litigation and weighs the likely outcome and possible consequences of the impending decision.
Bradley R. Marsh of Greenberg Traurig LLP focuses his practice on tax controversy matters, including payroll, property, business license, employment, franchise, parcel, district, sales, documentary transfer, transient occupancy, utility user, income, parking, gift and estate taxes. He is experienced representing clients in audits, litigation and administrative hearings, as well as analyzing transactions and business models, and providing legislative solutions.
In the first case from 2003 (Hyatt I), the taxpayer, Hyatt, sued the California Franchise Tax Board (FTB) in Nevada after the FTB determined in an audit investigation that he had been a California resident for a longer time than he represented in his California tax returns. The court held in a unanimous decision that Nevada was not required to grant immunity to the FTB in Nevada's judicial system under the full faith and credit clause.
Over ten years later, the court has granted certiorari again. It heard oral arguments for California Franchise Tax Bd. v. Hyatt (Hyatt II) on Dec. 7, 2015. The two issues before the court this term are whether Nevada may constitutionally refuse to extend to states haled into Nevada courts the same immunities Nevada enjoys in those courts and whether Nevada v. Hall, which held the Constitution permits a sovereign state to be haled into the courts of another state without its consent, should be overruled.
What was the impact of Hyatt I on state taxation?
The California Franchise Tax Board (FTB) took internal measures to lessen the sting of some of their residency audits, because the FTB realized that it was likely to have other lawsuits if it continued to be as aggressive as it was in the Hyatt case's facts and circumstances. So, while California still has a very robust and detailed in-depth audit procedure, the state did soften its investigative approach a bit more, making it more desk-oriented.
With this second round of Hyatt, what impact could the court's ruling potentially have on interstate cooperation? Additionally, by joining amicus briefs that claim states should enjoy immunity from other states' courts, 45 states have indicated their support for the FTB. What key concerns do you think led these states to support the FTB?
From an academic standpoint, this second round of Hyatt is a more intense argument of the first one, as not a whole lot has changed in terms of the positions of either party. The amici are more intense as well.
Forty-five of the states have filed in support of California in this latest case; that is largely driven by this being a tax case. No state wants to be in a position to not only lose tax revenue but to have their audit investigations dissected and criticized by another state in the manner that was done in the first Hyatt case.
In California, the administrative appeal procedures do not allow taxpayers to criticize audit conduct as effectively as it was done by Mr. Hyatt's attorneys. By going through an out-of-state route, Mr. Hyatt's attorneys were able to expose a lot more wrongdoing on the record. States are not going to be happy about having their audits criticized openly. Those of us who practice in tax law know the ins and outs and the little secrets and techniques that are used by auditors to obtain information, but those techniques, such as third-party subpoenas, don't often get exposed in this way. And, of course, the Hyatt audit had some particularly inflammatory aspects to it.
In the realm of income tax, there are certainly states whose strategy is not to have an individual income tax at all so people move to that state. It seems to me those kind of states, like Florida, Texas or Nevada, may be in a position to want, or allow, people who have moved there to defend themselves against states like California, or so-called “high income tax states.” There could be a situation where you have a handful of states that allowed these lawsuits, didn't cap damages, and a whole body of law that gets created around tortious audits. I think this is somewhat unlikely though. The fact is that nearly every audit I've been involved in has been conducted professionally.
I also think it is unlikely that these types of issues will really seep into other areas of tax law. Residency audits are particularly personal; so, while it could seep into other areas, it is most likely going to be confined to these types of highly personal residency issues.
Have you seen a strain on the relationship between California and Nevada, or even other states, because of Hyatt I?
I have not. The FTB has admitted publicly in different presentations that it does find good audit candidates from Nevada, but I don't think that has hurt the relationship between the states themselves. Certainly the FTB has its radar set on certain types of movements they believe to be suspicious or not real residency moves, and generally those are movements to low- or no-tax jurisdictions right before large income events.
Other than that, there is always this sort of, depending on your viewpoint, healthy banter among some states that are trying to jockey for both wealthy individual residents and businesses to relocate to their state. But, again, I don't think from the standpoint of being in practice or being subject to a residency audit that people think there is some sort of battle between the states; this is an academic battle being waged by bureaucrats and commented on by scholars and practitioners. Apart from suspicious patterns the FTB might look for, I don't think there is any real tangible animosity between states out there.
What are the state tax implications of Hyatt II that taxpayers need to consider?
From the standpoint of most taxpayers involved in residency disputes, the first part of any interaction they have with the FTB will largely not be impacted by Hyatt. They are going to go through the regular audit process, which will consist of information document requests and, perhaps, interviews.
Assuming the case is decided in favor of Mr. Hyatt, if the FTB auditors commit an intentional tort and take the audit to a level that is not professional within the bounds that the FTB has set out, then it allows taxpayers recourse. They will have the ability to recover damages when they are being impacted by overly aggressive audit activity, which can be an important check on the investigative powers of a state. That is what Hyatt's attorney discussed in oral arguments—his point is that maybe the sovereign immunity notion makes sense in some instances, but if it is overapplied, there is really nothing to protect a nonresident from overly aggressive audit activity in another state.
According to the Multistate Tax Commission's amicus brief, adhering to Nevada v. Hall would likely result in taxpayers essentially forum shopping to get the most favorable result and thus delaying states' tax enforcement processes and interfering with states' taxation cooperation. Do you see this as a likely outcome if the court upholds its prior decision in Nevada v. Hall?
As to the forum-shopping argument, how many people are really going to leave California and decide where to live based on whether or not California is going to commit a tort against them in a residency audit? I view that as being highly unlikely; so, to me, that part of the argument really doesn't make a lot of sense from a practical standpoint.
The part about a state having an interest in collecting money that is owed is a standard tax policy argument. Part of the issue, however, is whether California is even owed that money. It is definitely disputed and, in this case, Mr. Hyatt claims that he does not owe the money to California because he lives in another state. So, the FTB's argument rests on the premise that the money is actually owed.
There is not a whole lot out there in the law about states reaching outside of their jurisdiction to go after people in other states for money in this manner and to collect on it. It does seem to me that other states should protect their citizens, in some manner, from an adverse state doing so. California would not like it, for example, if another state was reaching in and going after all its citizens and saying “you owe money” and then saying “you have no process other than to go to that other state, contest it, endure a personal audit and then go through a lengthy administrative process.”
During oral arguments, Justice Kennedy seemed displeased with the notion that states could potentially discriminate against other states by way of comity agreements. Do you see this being a problem if the court rules that state immunity is not a constitutional right?
This is one of the policy arguments that the FTB put out in its briefing and has gained traction—this idea of messy comity situations where you're going to get states providing favorable treatment to different states. It is interesting how many of these cases right now, such as the recently decided Gillette case, are examining the ability of states to enter into compacts or agreements and whether those are even binding, and how you would make them binding or unbind from them. You can certainly understand the court's hesitance to be in a position where it is just going to let the states freely contract with other states and then let the law get made around that. It is hard to predict what would occur. Based on the amicus briefs, it appears that approximately 45 states would be on the same page, so maybe it is not that complicated. But at the end of the day, comity agreements are a concern that the justices will be weighing, because it is both developing law and a great unknown.
What do you think the preferred outcome in Hyatt II is for taxpayers?
Obviously, taxpayers want to have recourse if they are put in a position where torts have been committed against them. It seems like a low number to put a limit on ($50,000), which is essentially what was being argued by the FTB, so I think taxpayers would want to have the ability to recover something more akin to the actual damages that might result when someone disparages them to their religious organization or their business acquaintances, partners, family members—present and former. Taxpayers would want to have some form of recourse that was greater than a $50,000 amount; and, from that standpoint, it would be a huge taxpayer win to be able to have a limit that was more reasonable and represented something that tied to actual damages.
How do you anticipate the U.S. Supreme Court ruling?
The FTB has put extensive policy arguments in its briefing that they believe will support the court switching gears and getting away from Hyatt I. There is obviously some question as to why the court would grant review of a question it really has already decided. Maybe there has been a change of heart among the members of the court or a different concern has struck a nerve—why else would they take it for review, as it is essentially the same case? Either the court will refine its decision and place some form of a limit or test in there that doesn't currently exist, or it will uphold its last decision. I don't see it completely going against Hyatt I, so probably the most likely result would be some refinement of Hyatt I.
During oral arguments, Justice Ginsburg pointed out that California is now making the argument that its prior argument in Nevada v. Hall was wrong. It is ironic that the FTB is on the other side of that now. But at the end of the day, there is simply not a lot of law on this subject. Hyatt's attorneys have the slightly better argument, but it is impossible to predict what the court will do.
This is a great case, and it is a constant reminder, to me, that in the realm of tax, our fundamental rights are always at stake.
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