TCS Daily

Worse Than the IRS?

By Mark Schmidt - December 8, 2003 12:00 AM

John Marshall, the first Chief Justice of the U.S. Supreme Court, wrote that "the power to tax involves the power to destroy," and widespread abuses by the IRS proved the enduring truth of Marshall's observation. Congressional hearings in the mid-1990s revealed that the IRS regularly disclosed confidential taxpayer information, improperly calculated tax liabilities, arbitrarily enforced tax laws, and even conducted armed raids on innocent taxpayers.


Although the worst excesses of the IRS have been curbed -- for now -- thanks to reforms enacted in 1998, taxpayers around the country face a new threat from inept and increasingly aggressive state tax collectors.


Consider some of these highlights:


  • Pennsylvania's tax collection bureau lodged a criminal complaint and levied a fine of $352 against a 17 year-old for failing to file a local government income tax return declaring $316 she earned as a part-time swim instructor -- even though the entire $3.16 in taxes due had already been withheld from the teenager's paycheck.


  • The Kentucky Revenue Cabinet ordered 25,000 taxpayers to pay a late-filing penalty despite the fact that all had filed timely returns.


  • Several east coast states have assembled a tax cartel to share information about residents' out-of-state purchases in order to collect so-called "use" taxes for items such as furniture and electronics.


  • The National Governors Association is backing federal legislation that would force retailers to collect sales taxes on Internet and catalog purchases made by out-of-state consumers, even though those businesses have no physical presence in the state and do not receive any services from it.


But California's Franchise Tax Board (FTB) might be the worst offender. The FTB is both unprofessional -- it once mailed 8 million tax returns with the taxpayers' Social Security numbers clearly printed on the outside -- as well as downright devious.


Just ask Gil Hyatt. An independent inventor of computer processors, Hyatt derived a comfortable income from licensing his patents to various manufacturers. Perhaps frustrated with California's high taxes, Hyatt -- like tens of thousands of other Californians -- moved to Nevada, which does not impose a state income tax.


Although Hyatt dutifully filed a California "Part Year Resident" income tax return for 1991, he received notice of a "residency audit" in 1993, a full 21 months after becoming a resident of Nevada.


The FTB audit was more like an assault and battery. California FTB auditors descended upon Nevada, where they trespassed on Hyatt's property, rummaged through his mail and trash, and questioned neighbors and even store clerks over Hyatt's whereabouts. The agency sent subpoena-like letters to Hyatt's business associates in Nevada informing them that Hyatt was under audit and demanding personal information about Hyatt. Unsurprisingly, these activities badly damaged Hyatt's professional standing and business relationships.


Based on its "investigation," the FTB demanded that Hyatt pay $5.5 million in income taxes and an additional $9 million in penalties. Clearly, the FTB was looking to deliver a knockout blow that would make an example out of Hyatt and scare other taxpayers into submission.


Hyatt swung back by filing suit against the FTB in a Nevada state court.


Deposition testimony showed that FTB employees destroyed records favorable to Hyatt, disclosed his business secrets, and engaged in a purposeful policy of over-assessing tax delinquencies and penalties in order to intimidate taxpayers.


The suit made its way to the Nevada Supreme Court in 2002, which ruled that Hyatt had a right to sue the FTB for intentional torts against him.


The FTB appealed to the U.S. Supreme Court, where the FTB was forced to concede that its theory of absolute immunity meant California should be free to send tax collectors into other states to beat up alleged tax delinquents. Faced with this sort of reasoning, in April 2003 the Court unanimously ruled that Nevada courts did not have to honor California's law immunizing its tax collection agency.


On one hand, Hyatt's Supreme Court victory is a big win for state taxpayers -- the FTB's defeat certainly sent a message to the 35 states that filed amicus briefs supporting the FTB's right to engage in KGB-style tactics. On the other hand, one wonders how many individuals will have the determination and resources to take their fight all the way to the U.S. Supreme Court when the taxman tramples their rights. The FTB spent $2.4 million in taxpayer dollars to hire a private law firm, in addition to expenditures for state Attorney General and FTB staff time.


As big-spending state governments continue to turn the screws on taxpayers, one can only hope that the Hyatt case makes the revenuers think twice before using the power to tax as a power to destroy.


Mark Schmidt is Director of Programs for the National Taxpayers Union Foundation.


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