Though typically dismissed as dry and highly technical, some tax controversies can be exciting and fresh, creating novel questions of state and federal law with important consequences not just for the taxpayer but the operation of government itself. One such controversy is the 24-years-long-and-counting battle between inventor Gilbert P. Hyatt and the California Franchise Tax Board (FTB). Final decisions from the various jurisdictions asked to hear the case have ranged from outright dismissal to a $10.5 million judgment against Hyatt, and even a $500 million judgment against the FTB (subsequently set aside). After being heard in California, Nevada, New York, and the U.S. Supreme Court (SCOTUS) (twice), the case is currently headed back to the Nevada trial court on remand from the Nevada Supreme Court. What began as a routine audit by California became over the last quarter-century a law school case study for the ages.
Hyatt is recognized as the inventor of the “integrated circuit microprocessor,” which “shrunk the hardware necessary to run a computer to the size of a single silicon chip… The invention fueled the global personal computer revolution” and remains a vital component of computer, tablet, and cell phone functions today. Hyatt received a patent for the technology in 1990 and began receiving enormous royalty checks from the companies using it. Hyatt claimed to have moved his residency from California to Nevada in September of 1991 and stopped paying California state income taxes.
In 1993, after reading a newspaper article about Hyatt’s new-found riches, an auditor from the California FTB decided to review Hyatt’s 1991 state income tax return and found that he had only reported 3.5 percent of his total taxable income for 1991. Based on discrepancies surrounding underreporting of income and the exact date of Hyatt’s move, the FTB opened a full audit.
Heating Up: He Said/FTB Said
As a result of the 1991 FTB audit and a subsequent audit of 1992, the FTB issued a Notice of Proposed Assessment in 1996 totaling $3.3 million in unpaid taxes and fraud penalties for the 1991 tax year, and in 1997, a close to $10 million assessment for the 1992 tax year. Hyatt immediately challenged the assessment, and the FTB upheld its determination.
The case then moved to the California State Board of Equalization (SBOE), the state’s former appellate tax court. Using factors to establish residency taken from Appeal of Stephen D. Bragg, an earlier SBOE decision, Hyatt pointed to the sale of his California residence in 1991, obtaining a Nevada license, renting an apartment in Nevada, and opening a Nevada bank account as evidence of a true domicile change. The FTB countered by asserting that Hyatt’s actions were illusory: the sale of his California residence to an assistant was a sham, and the Nevada bank account and license were merely an attempt to deceive the FTB in order to live in California but avoid paying California state income taxes.
Finally, in 2017, after the interest on penalties sought by the FTB ballooned to $55 million and vast sums of money were collected in legal fees, the SBOE ruled in favor of Hyatt and determined that he had moved to Nevada in 1991 for tax purposes. The decision was mostly in Hyatt’s favor, although the court ruled that 100 percent of the 1991 patent income was sourced to California.
On Fire: Tort Claims and Constitutional Jurisdiction
In 1998, shortly after the FTB issued its Notice of Proposed Assessment, Hyatt then sued the FTB in Nevada for intentional torts and bad-faith conduct committed by the FTB auditors. Among several claims, Hyatt asserted that the FTB combed through his trash in violation of Nevada state law, obtained private emails, and examined private religious activities at his place of worship. Hyatt further asserted that demands for information sent to Japanese companies holding his patents were part of a conspiracy to destroy his Japanese patent business. Although the conspiracy claim was dismissed, the tort action was allowed to continue against the FTB.
California first asserted that the FTB is immune from Hyatt’s tort action. California law immunizes state agencies from lawsuits that result from activities related to the collection of tax. The Nevada Supreme Court disagreed, writing that constitutional comity requires only that California agencies be immunized to the extent Nevada agencies enjoy. The Supreme Court of the United States affirmed the decision. This decision led to a remand back to the trial court and the jury verdict of $500 million against the FTB, including $250 million in punitive damages. California balked at the judgment and appealed continuing to cite sovereign immunity, Full Faith and Credit, and comity.
The Nevada Supreme Court decided in 2014 to reduce the judgment from $500 million to $1 million. The court wrote that, under constitutional comity, California agencies may utilize Nevada’s statutory cap of $50,000 on damages against state agencies. However, Nevada’s interest in providing adequate redress to a Nevada citizen harmed by another state’s agency overcomes any constitutional comity concerns. The reduced $1 million judgment represented the portion of the district court judgment set aside for fraudulent behavior, an amount which the Nevada Supreme Court decided was adequate redress.
SCOTUS granted certiorari and heard the case in 2016. After receiving support for the FTB from 45 state amicus brief filings, the Court set aside the decision of the Nevada Supreme Court under the Full Faith and Credit Clause, writing that Nevada had engaged in a ‘policy of hostility to the public Acts’ of a sister State.’ Affirmation of the $1 million judgement represented a constitutionally hostile act, utilizing a special rule of law that applied only to California. SCOTUS rejected Nevada’s policy concerns and asserted that California state agencies must enjoy the same damages cap which protects Nevada state agencies. The Court remanded the case back to the Nevada Supreme Court, which in turn remanded to the district court for a redetermination of damages.
In terms of entertainment value, this ongoing legal battle has everything: drama, governmental invasion of privacy, novel constitutional issues, and the award, and subsequent loss, of half a billion dollars. The cases also highlight the surprising scope of tax law, which touches almost every other area of the law. Despite its unusual duration, the dispute continues at the district court level, which brings the possibility of more fireworks to come.
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: What authority should the courts of one state have over the governmental agencies of another?
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