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State of California November 7, 2006 Election
Smart Voter

Horror Stories from the Tax Bureaucracy

By Bill Leonard

Candidate for State Board of Equalization; District 2

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Bill Leonard's examples of why taxpayers need better protection and more rights.
I was elected to the state legislature as a Prop. 13 advocate. I supported the reform to get property taxes in check, give taxpayers some predictability and limit government's expansion. As a legislator I spent 24 years opposing higher taxes, and now as an elected member of the state Board of Equalization (BoE) I am continuing the fight for taxpayer rights. There are some who think dealing with the minutia of tax law day in and day out may be boring, but I have discovered that it is anything but. I have found the cases that come before the Board to be as heart wrenching, infuriating and frustrating as any soap opera plot. In that drama are important lessons for taxpayers.

Early on in my term I discovered that there are no bleeding-heart liberals on the Board, only bleeding heart conservatives. A gentleman who seemed to be in his 60s appeared before us on behalf of his father. Dad was in his 80s and many years yet he still kept his California insurance license active. He was proud of having the license, even though he no longer worked. One year he became very ill and in the confusion of hospital stays, doctor visit and medications, Dad did not file his taxes. He did not owe any money on his small pension, but because he failed to file, the state's income tax agents assigned an amount of income to him. That's right: if you do not state your income, the state will make it up for you! In this man's case because he held a professional license, the state used Census data to determine the average income of all insurance agents in the state and told him that is what he owed. The man's son told us that he could not prove that Dad did not make that money. If all his old clients wrote to us and said they did not do business with him, would that prove it? If all the companies Dad brokered for wrote to say they had not issued any policies through him, would we accept that as proof? The Board voted 3-2 against the man's appeal and he was required to pay income taxes on some $40,000 of income he did not earn. My advice to everyone is to file your return no matter what.

I believed that man owed no money, but there are other cases where taxpayers clearly do owe. Even in those cases, the Board can use our discretion to adjust the penalties. There are often cases where I believe that is more than justified, but I am usually outvoted. Consider the following examples.

A woman who had a home-based business appeared before us because she had been told she owed the state sales tax on the item she sold. Her business was selling carrots to racetracks to feed horses that were visiting during races. She kept detailed records of every order, every purchase, every shipment and every payment. In fact, her records were so good--all on her PC--that Board auditors actually raided her home with a search warrant, convinced there must be another set of books because no records were ever this neat. Ultimately the state had to concede that there was nothing wrong about her bookkeeping except that she had failed to remit sales tax to the state. She wondered, as you may be, why she owed sales tax since what she sold was carrots and food is exempt from sales tax. Fair question, but the answer was bad news to her: food is only exempt from sales tax if it is for human consumption. She owed back taxes on every carrot she had ever sold to the racetracks.

In another case, the man knew he had made a mistake and threw himself at our mercy. He was an African-American gentleman who had heeded the call after the Rodney King riots for African-Americans to own businesses in South Central Los Angeles. He bought a liquor store from a Korean gentleman and paid $5,000 for the inventory. At this point in his story he said, "I'm guilty of being a stupid businessman." He did not review the inventory thoroughly and once he was in the store he noticed that the labels of the liquor had been singed when the store was firebombed in the riots. Knowing he could not sell alcohol that had been in a fire, he loaded it up and took it to the county dump. A few years later, the auditors told him he had not paid sales tax on the initial inventory and he explained that he had not sold it, he had dumped it and even produced the receipt from the dump. Unfortunately, that receipt did not say what was dumped, or how much was dumped, and he had no pictures or other documentation to prove what he had taken to the dump. Three of my colleagues voted against giving this entrepreneur a break even though he explained that if we ruled against him he would sell his business to pay the bill. My colleagues voted to put him out of business just to collect taxes on inventory that was never sold.

Each of these cases demonstrate the need for businesspeople to understand how tax law applies to them, to keep impeccable records and to ask for tax advice before getting too far into their business. The BoE will provide written advice to your specific situation, but you have to ask for it.

Sometimes though, a businessperson pushes the line in the wrong direction, though not maliciously. A man in the Bay Area operated a teddy bear factory. In addition to selling teddy bears, he offered tours of his factory. Everyone who took the tour received a small teddy bear. He charged for the tour, but not the bears. Unless you did not take a tour, in which case you had to pay for the bear, and if you paid for the bear, sales tax was charged. The tour and the bear that you could buy without the tour cost the same amount. The tour was not taxable, but the bear--even given away as a gift--was taxable. I hated to vote against this generous man, but his logic that the tour fee was not the charge for the bear just did not hold water.

Another one that did not pass the giggle test was the homeowner who was appealing the denial of a charitable deduction he had taken on his income taxes. The homeowner was from a southern California beach city and was planning to build a new home but first had to remove the existing house. He "donated" the house to a nonprofit organization that promised to move the house to a different location and then place a poor family in it. However, the homeowner took out a demolition permit from the city, not a permit to move the residence, and the nonprofit organization then disappeared, having provided no evidence that the demolished old home had been rebuilt for a needy family elsewhere. Another outrageous one was the movie theater chain arguing that movie popcorn is not "hot" and therefore not subject to sales tax. They even brought in scientists to explain that the contraptions we think keep the popcorn hot for us are not meant for that purpose at all, but are, rather, designed solely to keep the popcorn dry. This simply did not pass the giggle test.

Another income tax appeals case demonstrated to me that there are malicious people in the world. A man appealed to us because the Franchise Tax Board said he owed income tax on wages he never earned. Turns out that a past employer submitted a false W-2 form spiking his wages quite high. The problem is that the burden of proof in all tax cases is on the taxpayer, not the government, which has the burden of proof in any criminal matter.

How was this man meant to prove that he did not earn what the government said? We need to do a better job protecting the rights of taxpayers. They should have the equivalent of public defenders available to help them when they appear before the BoE. The burden of proof should be on the government, and the government's tax agents should be restrained in gathering evidence, just as police officers are.

I remember questioning the findings of some auditors who were investigating a topless bar. Ostensibly the auditors were trying to determine whether the bar was remitting sufficient sales tax for the number of drinks it served. They took measuring devices into the bar, poured in sample beverages and measure the amount of alcohol to compare to the bar's records. The problem is that they took several auditors and returned on several occasions, all during performances by topless dancers.

The most egregious case of BoE employee behavior occurred during a business audit. When the business owner left the room, the auditor took records off the man's desk. When he return to the office, he told his boss he had found and taken the records, so the supervisor went to the legal department and requested a subpoena, not telling the attorney that the records were already in the BoE's possession. The auditor returned to the business with the search warrant but told the owner not to bother looking for the listed records because he already had them. I sought to fire the auditor for stealing and perjury. I was rebuffed by the State Personnel Board, which determined that this criminal act only warranted a small pay cut for a few months. If a police officer had stolen evidence like this, the case would have been thrown out and the officer would have been severely punished. In this case, the taxpayer still had to pay and that employee is still on the job.

Tax agents are also not constrained in how they can search for evidence that you are evading taxes. They are immune, and I have heard of cases where they have trespassed, gone through trashcans, interviewed personal physicians, and the like. In one case, the tax agents were suspicious of a wealthy woman who had opened a dress shop. The dress shop did not make a profit and the tax agents did not believe she even tried to do so. In fact, they believed she was simply pursuing a hobby and were penalizing her for not being a serious enough businesswoman.

Tax law is rich with the drama of daily life: people making a living, people making mistakes, people making me wonder how our tax law can be so complex that at times I am angry, other times I laugh, and sometimes I cry. In that I find it more important than ever to fight for lower taxes, for taxpayer rights and for government restraint.

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