Taxpayers being subjected to difficult audits by taxing authorities often like to wish they could respond and get back at the government and the auditor that has made life so very difficult. But other than asserting taxpayer’s rights in the audit, can the taxing authority be liable to the taxpayer for an abusive audit? The answer is yes, at least in some states.
In 2016, the United States Supreme Court issued a decision ruling that the Franchise Tax Board of California was subject to a civil lawsuit brought by a Nevada taxpayer in Nevada state court based on an abusive tax audit. However, the damages imposed upon the California Tax Board were limited to those amounts that Nevada state agencies could be liable for taxpayer torts, which was limited rather than the millions of dollars of damages the taxpayer sought.
In Franchise Tax Board of California v. Hyatt, 136 S.Ct. 1277 (2016), a California resident had allegedly moved to Nevada, a move which saved the newly minted Nevada resident millions of dollars in California state income taxes since Nevada does not have a state income tax. The California Franchise Board aggressively audited and investigated the taxpayer as part of a residency determination. The audit included looking through the windows of his house, rummaging through his garbage and calling business associates. The taxpayer challenged the residency determination before the California Franchise Board and continues to contest his California residency more than 11 years later in California-based litigation.
However, not being placated by just the opportunity to challenge California residency, the taxpayer also sued the California Franchise Board in Nevada state court alleging multiple tort claims based upon both negligence and intentional torts. In Nevada, the case ultimately went to trial and a Nevada jury decided against the California Franchise Board and awarded nearly $500 million in tort damages. The Nevada Supreme Court ultimately reduced the award to $1 million dollars, notwithstanding that a Nevada agency would have been liable for only $50,000 had the case been against the Nevada taxing authorities.
The United States Supreme Court reversed the million dollar damage award and instead imposed the $50,000 award since that is the maximum amount for which a Nevada agency could have been liable. The United States Supreme Court ruled that to permit a judgment against another state agency in excess of an amount that Nevada’s own agency would have been required to pay violated the United States Constitution’s “Full Faith and Credit Clause.” The Full Faith and Credit Clause states that “full faith and credit shall be given in each state to the public acts, records and judicial proceedings of every other state.”
The United States Supreme Court ruled that the Nevada Supreme Court’s grounds for upholding a million dollar judgment against the California Franchise Board in an amount greater than a Nevada board would be liable for was insufficient reason to depart from constitutional principles of full faith and credit. The Nevada court applied a different, special damages standard to California which discriminated against California and therefore violated constitutional full faith and credit.
However, the taxpayer can at least claim a moral victory in a judgment against the California Franchise Board for $50,000. However, Hyatt is silent on whether the taxpayer can also recover his legal fees of the trial and appeals. If not, no doubt the costs of ligation greatly exceeded many times over the award of $50,000. But the value of framing on the wall a judgment against the California tax agency: priceless.
In an upcoming article, I will analyze other lessons learned from Hyatt and whether the taxpayer may be able to sue the state of Montana and other surrounding states for an abusive tax audit.
Jared M. Le Fevre is a Partner in the Tax, Trusts and Estates Practice Group of Crowley Fleck PLLP. Mr. Le Fevre represents taxpayers before the IRS, IRS Independent Office of Appeals, Tax Court, Federal District Court and state tax agencies throughout Montana, Wyoming, North Dakota, Idaho, and Utah. Mr. Le Fevre is involved in federal and state and local tax audits, appeals, and tax resolution throughout these western states. Mr. Le Fevre also advises clients on the tax effects of business and real estate transactions.