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Tax That DC?!?! FCA Suit on Residency Brings Business Intelligence Company into the Crosshairs

For the first time since the enactment of the False Claims Amendment Act of 2020, the DC Attorney General’s (AG’s) Office has used its new tax enforcement powers to pursue an alleged personal income tax deficiency. This development brings to the forefront a long-simmering constitutional problem with DC’s statutory residency law and offers a stern warning to businesses that assist key employees and executives with their personal tax obligations.

The press rapidly and widely reported on DC’s lawsuit against MicroStrategy Co-Founder, Executive Chairman and former CEO Michael Saylor for alleged evasion of D.C. personal income taxes, which was made public this week. The case alleges that Saylor wrongly claimed that he was a resident of Virginia or Florida (rather than DC) since at least 2012.

The case was originally brought under seal by a relator under DC’s False Claims Act in April 2021—less than one month after the False Claims Amendment Act took effect. Using its new tax authority, the DC AG’s Office filed a complaint last week to intervene (taking over the case going forward). Interestingly, when the DC AG’s Office took over the case, it added MicroStrategy as a defendant under the theory that the company conspired to help Saylor evade DC personal income taxes. Under DC’s False Claims Act, both Saylor and MicroStrategy could be liable for treble damages if a court rules in favor of the DC AG’s Office.

ISSUES WITH DC’S “STATUTORY RESIDENCY” TEST

While determining where an individual is a resident for state and local tax purposes generally requires a fact-intensive analysis, the case against Saylor also implicates DC’s unique (and likely unconstitutional) statutory residency standard. DC’s statute is fundamentally different than statutory residency standards in other states. Most states only tax individuals having their domicile in the state as residents, while some states also have a “statutory residency” test to classify individuals as taxable residents. In most states, a person is classified as a statutory resident if they (1) maintain a permanent place of abode in the jurisdiction and (2) spend more than a specific number of days (typically 183 days) in the jurisdiction.

DC truncates this standard and classifies someone as a statutory resident if they merely maintain a personal place of abode in DC for more than 183 days. Thus, no amount of actual presence of the individual in DC is required. The problem created by this one-of-a-kind standard should be obvious: someone can (as many high-net-worth individuals often do) maintain a residence for 183 days in more than one jurisdiction. Thus, the plain language of the statute would violate the Commerce Clause of the US Constitution because it runs afoul of the internal consistency test. Under this test, a statute is unconstitutional if under a hypothetical situation in which every jurisdiction has the same law as the one being challenged, more than 100% of the tax base would be subject to tax. Here, if every state had a statutory residency test applicable to anyone who had a [...]

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State False Claims Acts: “Knowing” Why They Matter for Tax Professionals

Like the federal government, many states have adopted False Claims Act (FCA) provisions that exclude tax matters from coverage. The federal model makes clear that matters under the Internal Revenue Service are not covered by the law,[1] and in the vast majority of cases, states also explicitly exclude tax from coverage.[2] However, there is a growing number of states seeking to extend FCA liability to tax cases in which “knowing” causes of action apply to any person that knowingly conceals, avoids or decreases an obligation to pay the state.[3] In such states, FCA liability, including punitive penalties and damages, will be argued to create liability for certified public accountants (CPAs) and other tax professionals who advise clients to take a favorable tax position on a tax return or simply file a return with an “error.” Under a “knowing” standard, an “error” is asserted to exist when the taxpayer’s position differs from someone else’s view of the law—the reasonableness of the position simply does not matter.

This risk is not hyperbole. On March 23, 2022, New York Attorney General Letitia James issued a warning to cryptocurrency investors and their tax advisors: “The consequences of a taxpayer’s failure to properly report income . . . are potentially far-reaching and severe [and could] result in taxpayer liability under the New York False Claims Act,” adding, “False Claims Act liability may also extend to tax professionals advising clients. . .”[4]

New York and Washington, DC, already extend FCA liability to tax cases and apply a “knowing” standard. In other states, FCA expansion bills have started popping up, too. For instance, there is currently a FCA bill before Ohio legislature proposing to extend FCA liability to tax cases and any person that “[k]nowingly present[s], or cause[s] to be presented, to an officer or employee of the state. . .a false or misleading claim for payment or approval.”[5] Recently, a proposal to expand the Connecticut FCA to tax cases failed to advance.[6] While the Connecticut FCA already includes a “knowing” standard, it only applies to false claims made in the Medicaid context. Additionally, New York legislature is considering a bill that would further expand the application of its FCA’s “knowledge” standard to “obligations” under the Tax Law.[7] However, the term is not defined in the Tax Law, making it unclear whether it would apply only to the “obligation” to file a return or to situations where a CPA or tax advisor provides general advice on a specific tax matter.

The trend to loosen the standard for state FCAs liability is a problematic shift leading to lawsuits that will assert that simply providing advice or a good-faith interpretation of the tax law to a client could result in liability under a state’s FCA. Adding insult to injury, these suits will threaten treble damages, attorneys’ fees and civil penalties per occurrence. Taxpayers and their advisors should know the breadth of each state’s FCA provisions and take them into account as [...]

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False Claims Act Risk for Unclaimed Property Holders

In what has become an unfortunate trend, unclaimed property holders continue to be subject to lawsuits under state false claims acts (FCA – also called a qui tam or whistleblower action) for alleged underreporting and remittance of unclaimed property obligations. More than 30 states have a false claims act with whistleblower provisions and nearly all are applicable to unclaimed property. While an honest mistake should not create liability under an FCA, a holder could be liable if its failure to report not only was done knowingly, but also if such failure to comply was done with deliberate ignorance or with reckless disregard. Actual fraud is not a necessary precursor to being subject to false claims act liability.

Potential liability under state FCA laws is far in excess of any liability under an unclaimed property audit. FCA laws impose treble damages (3x the value of the underreported property), penalties, interest and attorney’s fees. Successful claims under these laws are not just extremely punitive to the holder but also lucrative for the person bringing the lawsuit who can earn up to 30% of the ultimate recovery to the state. Liability under a FCA can turn a holder’s failure to be appropriately diligent in determining its unclaimed property compliance obligations into a multi-million dollar legal battle with long-term public relations implications. The fact that a holder has already been audited or that the State may have historically agreed with the holder’s position may not prevent a FCA case progressing.

A holder’s FCA unclaimed property horror begins with an investigation, which can be prompted by either claims by private parties (called relators) or the state attorney general’s office. A relator may be a disgruntled employee or any clever person with good research skills. The holder may not even know the claim has been filed and the investigation has been going on for years. These investigations may open closed periods and, once the holder is informed, are very interrogation-like, with the holder often knowing very little about the underlying claims until the case is unsealed. Eventually, these investigations may turn into a public court battle with a sometimes politically motivated state attorney general on the other side. Even if the state AG’s office declines to proceed with the case, the private party initiating the case may nevertheless proceed.

While frequently FCA cases are settled before becoming public, several recent cases provide some background for holders looking for FCA examples. In a series of Delaware qui tam cases, more than 25 retailers and restaurants were sued by a former disgruntled employee of a gift card issuance and management company alleging unclaimed property compliance violations. All but one settled or was dismissed by the court. In New York, a court recently dismissed claims by an audit firm against nearly a dozen life insurers in response to allegations under the false claims act that the companies failed to report life insurance policy funds – alleging more than $14.5 billion in damages. Regardless of industry, these lawsuits are a [...]

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DC Council Expands False Claims Act to Tax Claims

The DC Council has passed an amended bill (the False Claims Amendment Act of 2020, B23-0035) that beginning as early as January 2021 will allow tax-related false claims to be raised against large taxpayers for up to 10 years of prior tax periods! This troubling legislation creates a real and imminent possibility of prior tax periods that are closed for assessment under the DC tax law pursuant to DC Code § 47-4301 being reopened by the DC attorney general and/or a private qui tam plaintiff.

While the introduced bill passed a first reading of the Committee of the Whole on Tuesday, November 17, 2020, by a vote of 8-5, the second reading (as amended) passed by a vote of 12-1 (a veto-proof supermajority) on December 1, 2020. The amended bill (as approved by the DC Council) will be sent to Mayor Muriel Bowser for consideration. If the mayor does not veto the bill or if her veto is overridden, the legislation will be assigned an Act number and sent to Congress for a 30-day review period before becoming effective as law. While extremely rare, Congress has an opportunity to reject the DC Council’s Act by passing a joint resolution, which must be signed by the president of the United States to prevent the Act from becoming law. Assuming this doesn’t happen, the Act will become law after the expiration of the 30-day Congressional review period. Assuming the Mayor quickly approves the legislation and Congress does not seek a joint resolution disapproving the Act, the legislation passed by the DC Council could take effect as early as next month!

As amended, the False Claims Amendment Act of 2020 passed by the DC Council will:

  • Remove the taxation bar that exists as part of current law (see DC Code § 2-381.02(d)) and replace it with explicit authorization allowing by the DC attorney general and private qui tam plaintiffs to pursue taxpayers for claims, records or statements made pursuant to Title 47 that refer or relate to taxation when “the District taxable income, District sales or District revenue of the person against who the action is being brought equals or exceeds $1 million for any taxable year subject to any action brought pursuant to this subsection, and the damages pleaded in the action total $350,000 or more.”
  • Require that the DC attorney general “consult with the District’s chief financial officer about the complaint” when tax-related claims are filed by a qui tam
  • Prohibits a claim by a qui tam plaintiff “based on allegations or transactions relating to taxation and that are the subject of an existing investigation, audit, examination, ruling, agreement or administrative or enforcement activity by the District’s chief financial officer.”
  • Not require the District’s chief financial officer “to produce tax information, or other information from which tax information can be inferred, if the production thereof would be a violation of federal law.”
  • Increase the maximum statutory reward for informants under the Taxation [...]

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False Claims Act Tax Expansion Bill Advanced by DC Council

The DC Council has once again advanced a bill (the False Claims Amendment Act, B23-0035) that would allow tax-related false claims against large taxpayers! The bill passed a first reading of the Committee of the Whole on Tuesday, November 17, 2020, by a vote of 8-5. The bill is sponsored by Councilmember Mary Cheh, who introduced identical bills over the past few legislative sessions that ultimately were not passed. The troubling bill is now eligible for a second (and final) reading at the next legislative meeting on Tuesday, December 1, 2020.

As introduced, the bill would amend the existing false claims statute in the District of Columbia to expressly authorize tax-related false claims actions against a person that “reported net income, sales, or revenue totaling $1 million or more in the tax filing to which the claim pertained, and the damages pleaded in the action total $350,000 or more.” If enacted, it would make the District one of only a few jurisdictions that allow tax-related false claims actions across the country.

Practice Note:

The advancement of this legislation by the DC Council is a very troubling development for taxpayers doing business in the District and threatens to subject them to the same nightmares (and the cottage industry of plaintiffs’ lawyers) that states like Illinois and New York have allowed over the past decade. Because the current false claims statute includes an express tax bar, this bill would represent a major policy departure in the District. See D.C. Code § 2-381.02(d) (stating that “[t]his section shall not apply to claims, records, or statements made pursuant to those portions of Title 47 that refer or relate to taxation”). As we have seen in jurisdictions like New York and Illinois, opening the door to tax-related false claims can lead to significant headaches for taxpayers and usurp the authority of the state tax agency by involving profit-motivated private parties and the state attorney general (AG) in tax enforcement decisions.

Because the statute of limitations for false claims is 10 years after the date on which the violation occurs, the typical tax statute of limitations for audit and enforcement may not protect taxpayers from false claims actions. See D.C. Code § 2-381.05(a). Treble damages would also be permitted against taxpayers for violations, meaning District taxpayers would be liable for three times the amount of any damages sustained by the District. See D.C. Code § 2-381.02(a). A private party who files a successful claim may receive between 15–25% of any recovery to the District if the District’s AG intervenes in the matter. If the private party successfully prosecutes the case on their own, they may receive between 25–30% of the amount recovered. This financial incentive encourages profit-motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. Allowing private parties to intervene in the administration, interpretation or enforcement of the tax law commandeers the authority of the tax agency, creates [...]

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New York Legislation Proposes to Retroactively Remove FCA Culpability Standard for Tax Law Claims

With Halloween just a few weeks away, a scary proposal is brewing in the New York State Legislature that should give taxpayers chills. Companion bills Assembly Bill 11066 and Senate Bill 8872 were recently introduced by committee chairs (Assembly Ways and Means Chairwoman Helene Weinstein and Senate Committee on Judiciary Chairman Brad Hoylman). This legislation would substantially expand the scope of the New York False Claims Act (FCA) for claims under the New York State Tax Law by retroactively creating a new tax-specific cause of action that would award single (as opposed to treble) damages, including consequential damages when the taxpayer makes a false statement or record material to their obligation to pay money to state or local governments under the tax law by mistake or mere negligence.

Specifically, the bill would not modify the existing “knowing” causes of action in NY State Fin. Law § 189(1) that, if proven, result in civil penalties, treble damages and consequential damages. Instead, the bill would create a new tax-specific cause of action with strict liability—i.e., no intent requirement that the violation be shown to have been committed “knowingly” (with actual knowledge or deliberate ignorance or reckless disregard for the truth). As a result, inadvertent non-reckless tax mistakes, misunderstandings or mere negligence of the law would result in the taxpayer being subject to a viable claim under the FCA—something that is currently expressly prohibited by law. (See NY State Fin. Law § 188(3)(b) (“acts occurring by mistake or as a result of mere negligence are not covered by this article”).)

To make matters worse, the companion bills (as introduced) would “apply to all false claims, records, statements and obligations concealed, avoided or decreased on, prior to, or after such effective date.” (§ 4; emphasis added.) Thus, if enacted, the bill would open the door to 10 years of backward-looking scrutiny of tax law violations in court by private relators and the New York Attorney General—including years of tax periods that are currently closed under the New York Tax Law or were settled with the New York Department of Taxation and Finance. (See NY State Fin. Law § 192(1) (“[a] civil action under this article shall be commenced no later than ten years after the date on which the violation of this article is committed”).) As a reminder, the FCA would continue to only apply to tax law violations with pleaded damages in excess of $350,000 by persons with net income or sales of more than $1 million in at least one tax year at issue.

Practice Note

As if managing tax audits and potential compliance mistakes administratively was not enough, the introduced New York companion bills would allow a separate parallel path for litigious private parties and the New York Attorney General to enforce the tax law as they see fit in court—creating a framework that is ripe to drag well-intentioned taxpayers through the mud and force them to either defend themselves through costly litigation [...]

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Alert: California False Claims Expansion Bill Advances to the Senate

Like the days of the Old West, last week a masked gang held up local businesses demanding their wallets. Unlike the days of the Old West, this was not the hole-in-the-wall gang, but the California State Assembly who, on June 10, 2020, approved AB 2570, a bill that authorizes tax-based false claims actions. If passed, AB 2570 would expand the California False Claims Act (CFCA) to allow private, profit-motivated parties to bring punitive civil enforcement tax-based lawsuits. The bill now heads to the California Senate where its predecessor bill, AB 1270, failed last year.

According to the bill’s author, Assembly Member Mark Stone, there are two key differences between AB 2570 and last year’s AB 1270. First, AB 2570’s definition of “prosecuting authority” has been revised to remove the term “counsel retained by a political subdivision to act on its behalf.” In his comments on the Assembly floor, Stone explained that this amendment was “sought by the bill’s opponents” as it prevents local governments from contracting with private attorneys to bring tax CFCA lawsuits.

Second, AB 2570 mandates that a plaintiff’s complaint must be kept under seal for 60 days and can only be served on a defendant by court order. According to Stone, this second amendment will prevent qui tam attorneys from bringing suit if they send demand letters to the taxpayer before the expiration of this 60-day period.

Although these amendments are minor improvements upon last year’s bill, they are not enough to prevent the rampant abuse that will certainly accompany an expansion of the CFCA. Moreover, as Stone has acknowledged AB 2570 rests on the faulty premise that insider information is generally required to establish a “successful” tax enforcement claim. In his comments to the assembly, Stone stated:

No one questions the ability of the Franchise Tax Board and the California Department of Tax and Fee Administration (CDTFA) to skillfully administer the tax law within their respective jurisdictions. This bill, rather, rests on the premise that there are individuals—often current or former employees of a company—who have access to information establishing that tax authorities have been misled as to the amounts owed by the company. These cases are difficult to uncover without the cooperation of an insider because there is no other way to bring the relevant documents and information to light if a company is determined to commit fraud.

However, as evidenced by the states where an FCA has been expanded to tax cases, such as Illinois and New York, very few FCA tax cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. As a result, expanding the CFCA to tax claims will only serve to hurt good-faith taxpayers who are already struggling to survive and recover from the economic impacts of COVID-19. Such legislation could force taxpayers to incur enormous costs or pressure them into settlements to make the case go away to avoid the [...]

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False Claims Never Die in California

Recently, AB 2570 has cleared the Assembly Appropriations Committee, which authorizes tax-based false claims actions—allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits. The bill is now on the Assembly floor for consideration and faces a June 19 house-of-origin deadline for passage. The bill is similar to a bill that failed to pass last year (AB 1270) after encountering intense opposition.

California’s current False Claims Act (FCA) bars its use in tax cases, a similar practice followed by most states with FCAs. This leaves initiation of tax enforcement to tax agencies that interpret and enforce those laws. In states where a FCA has been expanded to tax cases, such as in Illinois and New York, very few cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. FCA expansion undermines taxpayer reliance on tax agency interpretations and guidance, since alternative interpretations can be used by plaintiffs as the basis for their lawsuits against taxpayers.

Who brings FCA tax actions? Claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor. In a hearing before the Illinois House Revenue and Finance Committee, former Illinois Revenue Director Brian Hamer described the Illinois cases as being brought by a financially motivated third party adept at manipulating the qui tam process to victimize businesses that at most made an inadvertent mistake. At that hearing, several witnesses described being forced into settlements for amounts far exceeding any tax owed because the costs of litigation are so high. Mark Dyckman, the former General Counsel for the Illinois Department of Revenue, has said that “the cases have clearly interfered with the administration and enforcement of tax law and may have even ultimately cost the state money, though it’s impossible to quantify how much.” A 2007 study by Columbia Law Review concluded that 73 percent of qui tam actions are frivolous.

Why does FCA expansion to taxes lead to such rampant abuse? The treble damages financial incentive encourages profit-motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. In Illinois alone, the number of claims by one filer is in the thousands. Other problematic provisions in the California proposal that would tilt the playing field are a separate statute of limitations, a lenient burden of proof and use of sealed complaints, and extremely punitive damages (actual damages times three, plus $5,500 or more civil penalty for each alleged violation). The private attorneys deputized to act as tax enforcers get a percentage of the payment.

Supporters point to “tax gap” estimates of uncollected tax revenue and claim this bill will bring in billions in tax revenues. However, the vast majority of the “tax gap” consists not of missing corporate tax payments, but individual income taxes subject to little or no information reporting, with the Treasury Department particularly [...]

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False Claims Bill Advances in California – Taxpayers Beware!

California’s bill to authorize tax-based false claims actions—allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—cleared the Assembly Judiciary Committee on May 11 in a party-line vote. The bill, AB 2570, is sponsored by the committee’s chair, Assemblymember Mark Stone (D), and has strong backing from Attorney General Xavier Becerra. It now goes to the Assembly Appropriations Committee.

Proponents claim the bill only affects “tax cheats” but under similar laws in Illinois and New York, very few cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. Moreover, while there often is an erroneous assumption that most tax false claims actions are brought by “by-the-books” whistleblowers acting in the interest of the taxing jurisdiction, claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor.

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Alert: California False Claims Expansion Bill Preparing to Advance

The revived False Claims expansion bill in California, A.B. 2570, is on the agenda to be heard by the Assembly Judiciary Committee on May 11 at 10:00 am PDT. The proposal would authorize tax-based false claims actions, allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—an abusive practice that is prohibited under current law consistent with the vast majority of other states with similar laws. A nearly identical bill sputtered out last summer but has now been revived, as our colleagues covered in February:

AB 2570 is replete with problematic provisions, including: (1) the imposition of a separate statute of limitations that will arguably trump any shorter limitations periods imposed by the Revenue & Taxation Code (See Cal. Gov’t Code § 12654(a) which permits claims under the CFCA to be pursued for up to 10 years after the date the violation was committed, compared to standard three or four years for tax audits); (2) a more lenient burden of proof for elements of an alleged violation; and, (3) extremely punitive damages—violators are subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties including attorney’s fees.

Few of these cases will involve internal whistleblowers, actual fraud, or reckless disregard of clear law. Instead, the cases in Illinois (a state that has adopted false claims expansion to tax) usually involve inadvertent errors or good-faith interpretations of murky tax law. With the party bringing the case able to keep up to 50% of the proceeds, the only winners in the proposal is the cottage industry of money hungry plaintiffs’ attorneys that will descend and harass good-faith taxpayers in an effort to pad their own pockets.




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