California’s version of Les Misérables

Before Les Misérables morphed into movies, plays, musicals and even computer games, it was Victor Hugo’s epic 19th century novel, rooted in the French revolution, about the redemption of ex-convict Jean Valjean and the policeman, Inspector Javert, who was obsessed with pursuing and punishing him.

It’s not a stretch to see high-tech inventor Gilbert Hyatt as Valjean and California’s Franchise Tax Board (FTB) as Javert, relentlessly pursuing him for more than a quarter-century for taxes on his royalty payments.

Hyatt moved from Southern California to Las Vegas in the early 1990s, just as royalties on his pioneering microprocessor chip inventions began rolling in. Ever since, state tax collectors have contended that Hyatt was dodging legitimately levied income taxes.

Aspects of the dispute have gone as high as the U.S. Supreme Court three times and been aired in the Nevada Supreme Court, as well as in exhaustive administrative hearings in California before the state Board of Equalization.

Hyatt has alleged that state tax collectors rummaged through his trash, interrogated neighbors and in other ways harassed him, but he’s refused to give in.

“It’s been a horrible quarter-century,” Hyatt told Bloomberg Tax in a rare interview. “The FTB has used all kinds of tactics that I’ve been concerned it’s using with all taxpayers to extort taxes that aren’t owed.”

In 2017, Hyatt scored a major win before the Board of Equalization, which rejected the FTB’s claims of fraud, and ruled that Hyatt owed no state tax for income in 1992, but did for a part-year residence in California in 1991. It reduced his potential tax bite from $55 million to $1.9 million plus interest.

Shortly thereafter, Gov. Jerry Brown and the Legislature stripped the Board of Equalization of its jurisdiction over income tax appeals and transferred it to a newly created Office of Tax Appeals.

That change encouraged the FTB to ask the OTA, as it’s known, to overturn the Board of Equalization’s Hyatt rulings, contending that the board improperly admitted evidence from Hyatt about his residency. But this month, the OTA rejected the FTB’s request, leaving Hyatt as the clear victor.

Meanwhile, the last of Hyatt’s U.S. Supreme Court cases is also nearing an end. The court heard oral arguments recently on his allegation that FTB engaged in fraud and other tax collection practices. He’s prevailed in Nevada courts, but the FTB contends that state governments are immune from lawsuits in other states.

The Hyatt saga may not have the sweeping drama of Hugo’s novel, but could have dramatic impacts on California’s future tax collections.

It’s no secret that, like Hyatt, some wealthy Californians have established new residences in states such as Nevada, which impose little or no taxes on income, in reaction to high tax rates imposed by California.

It may not be a mass exodus, but even former Gov. Jerry Brown has expressed concern about the potential of tax flight.

The potential is heightened by the new federal tax overhaul, which limits deductions for state and local taxes to $10,000 a year. That means that California’s high-income residents can no longer soften the impact of state taxes by writing them off on their federal returns, beginning with 2018.

Those taxpayers generate a huge portion of state income. Income taxes account for 70 percent of state general fund revenues and the top 1 percent of taxpayers pay 50 percent of those income taxes.

Hyatt’s wins indicate that, if so inclined, they can flee without worrying about harassment by California’s tax collectors.

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