Seismic shift in tax litigation in New York State

The recently enacted New York State Budget Bill, S4009-C, included two key tax litigation provisions – one permitting the NYS Department of Taxation and Finance (the Department) to appeal Tax Appeals Tribunal (the NYS Tribunal) administrative decisions in certain circumstances, and one permitting whistleblowers to pursue False Claims Act cases against those who do not file NYS tax returns, but are required to do so (non-filers).

              Tax Appeals Tribunal administrative appeals

The administrative tax appeals process in NYS previously concluded when a taxpayer prevailed at the NYS Tribunal because, historically, the Department could not appeal and seek judicial review in the Appellate Division, Third Department, of any adverse decision of the NYS Tribunal.  This rule provided taxpayers with certainty at that level and reduced the potential for increased litigation costs on appeal. 

As of May 3, 2023, the Budget Bill permits the Department to appeal any NYS Tribunal decisions “that is premised on interpretation of the state or federal constitution, international law, federal law, the law of other states, or other legal matters that are beyond the purview of the state legislature.” 

While the law clearly permits the Department to appeal in those listed circumstances, it is unclear how broadly those circumstances will be applied as it may be subject to debate whether a decision is “premised on interpretation of the state or federal constitution…” or are a “legal matters that are beyond the purview of the state legislature.”  Like taxpayer appeals, appeals by the Department will go to the Appellate Division, Third Department.  As a practical issue, the Department could feasibly appeal any NYS Tribunal decision so long as one of their arguments “is premised” on the listed circumstances. 

The Appellate Division will now be tasked with determining whether the appeal fits within the statutory construct that permits the Department to seek judicial review.  Therefore, taxpayers may now need to argue that the appeal is improper and continue to argue the case on the merits if the appeal is proper.  The law applies to decisions issued by the NYS Tribunal on or after May 3, 2023.

Proponents of the law change cited the need for both litigants to have an opportunity to appeal as the NYS Tribunal is independent from the Department.  Previously, the State Tax Commission, which was part of the Department, exercised adjudicative functions, and there was no need for the Department to appeal its own determination.  Proponents also looked to the fact that, in close cases, the Tribunal could be incentivized to rule against the taxpayer because the Department had no right of appeal.  Then, at the Appellate Division, deference may be given to the Tribunal’s determination, which put taxpayers in a disadvantageous litigation position as a whole.[1]

Opponents of the law focus on the fact that an appeal right would create additional burdens on taxpayers and allow the Department to prolong cases by having the ability to appeal.  One concern is that the Department could continue appeals based on expense of the litigation (to the taxpayer) and cause cost-conscious taxpayers to forego their positions, particularly for smaller-dollar issues.  The lack of certainty upon a taxpayer win at the NYS Tribunal was also a concern for opponents.

While the Department may now appeal the Tribunal’s determinations in certain circumstances for NYS purposes, NYC law remains unchanged with respect to administrative decisions of the NYC Tax Appeals Tribunal (the NYC Tribunal).  Specifically, NYC Charter 171(b) states that “each decision of the [NYC] tribunal, shall finally and irrevocably decide all issues raised in the proceedings before it, unless the petitioner who commenced the proceeding seeks judicial review….” 

Interestingly, NYC is bound by decisions in the NYS Tribunal under NYC Charter 170(b) (“[t]he tribunal shall follow as precedent the prior precedential decisions of…the New York State Tax Appeals Tribunal….”).   However, appeals from adverse decisions of the NYS Tribunal are heard by the Appellate Division Third Department, while appeals from adverse decisions of the NYC Tribunal are heard by the Appellate Division First Department.  The Third Department’s decisions are not precedential on the First Department, although each Appellate Division does treat a decision on point by another NYS appellate division as persuasive authority. 

Therefore, there is some procedural complexity and the potential for “forum shopping” by taxpayers or by the taxing authority if a similar issue is raised in NYS and NYC contemporaneously.[2]

              False Claims Act expansion

The Budget Bill also expanded the of the NYS False Claims Act (FCA) to permit claims against non-filers.  The FCA is a whistleblower statute that provides for liability in circumstances where a taxpayer filed a “false claim” with the state and the whistleblower is compensated based on a percentage of the recovery.  The standard to be subject to an FCA case is “knowingly,” which is generally defined as actual knowledge, deliberate ignorance of the truth, or acting in reckless disregard of the truth.  The FCA has a ten-year lookback and provides for treble damages. 

NYS is one of only a handful of jurisdictions that permit False Claims Act cases in the tax context.  For example, the federal False Claims Act, which many states follow as a model rule, specifically excludes tax actions.  Prior to the Budget Bill, NYS did not have a provision that permitted an FCA case to be brought against a non-filer as there was no “false claim” made by such individual. 

New York Governor Kathy Hochul previously vetoed two iterations of the proposed amendments to the FCA, with the most recent veto occurring in January of this year.  In her January veto memo, she stated that, “[w]hile I agree that the non-filer loophole should be addressed, this bill is overly broad and goes significantly beyond how the federal government and other states pursue civil tax fraud.  It also contains an undefined retroactive lookback period that fails to provide notice to filers and raises due process concerns.

Interestingly, the Budget Bill’s FCA revisions are substantively the same as the prior bill that Governor Hochul vetoed, with the exception of the lookback period.  The NYS FCA remains a departure from how the federal government and other states pursue civil tax fraud. 

Moreover, the issue surrounding the law being overly broad is magnified in light of the 2018 Wayfair decision, which permitted states to require businesses to collect and remit sales tax based on economic nexus (eg, $100,000 of sales in the state).  While NYS has a minimum threshold to be subject to the FCA, many small businesses could feasibly face an FCA claim based on lack of knowledge rather than knowingly disobeying the law or in reckless disregard of the law. 

Part of the problem with non-filers being subject to tax is the complexity of NYS law.  As a problematic example, NYS promulgated a regulation in 1989 that imposed a $300,000 economic nexus threshold for sales tax purposes on taxpayers without having a corollary statute imposing the same.  The regulation was unconstitutional at the time of adoption, remained unconstitutional until the US Supreme Court’s decision in Wayfair in June 2018, and was never enforced by the Department, but remained an active regulation on the books. 

Pre-Wayfair, a whistleblower could have argued that taxpayers were going against a clear Department directive despite the regulation being unconstitutional, and their case could have been brought in a NYS trial court subject to a jury trial (ie, individuals who likely have no state tax technical background and could give credence to an argument that taxpayers should comply with the Department regulations, even if they believe the regulation is unconstitutional). 

Moreover, sales tax rules are notoriously difficult to decipher (recall the years when NYS taxed big marshmallows, but not small marshmallows).   The advances of technology have not decreased the complexity of NYS’s sales tax law.  It is possible that a company has no knowledge sales tax is due on their transaction, such as a company which crosses NYS’s economic nexus threshold, but honestly and erroneously believes that it does not make any taxable sales in New York.  Such a company could now be facing an FCA case due to a competitor alleging a violation because the company never filed a return, as there would have been no sales tax to report.

The minimum thresholds to be subject to the FCA are sales of $1 million for any taxable year and damages pled in excess of $350,000.  While this is an attempt to protect small businesses and avoid frivolous litigation, with the FCA having a ten-year lookback, a company would need only $1 million in total revenue for any one of those years and an average of $35,000 in NYS sales tax liability to exceed the minimum threshold.  Small businesses could easily fall within those parameters, allowing for frivolous lawsuits (eg, suing a competitor knowing that the cost of defending a lawsuit could exceed the potential liability) due to the low thresholds.

The Budget Bill provides that the FCA amendments “shall take effect immediately and in any pending case shall apply to any tax obligation knowingly concealed or knowingly avoided before, on, or after such effective date; provided however, that in any action filed after such effective date, this act shall only apply to tax obligations knowingly concealed or knowingly avoided on or after May 1, 2020.” 

It is unclear why the bill is fully retroactive for “pending cases,” but retroactive to May 1, 2020 for non-pending cases.  Due to the change in law, defendants would have no knowledge that a non-filer could be subject to the FCA at the time of non-filing regardless of whether a case is pending.  This concern is similar to the position that Governor Hochul took in her January 2023 veto of the prior law regarding the due-process concerns, along with also raising Equal Protection concerns as defendants would be treated differently based on when a whistleblower brought the case, even if both defendants committed the identical purported violation at the same time and in the same manner.

Going forward

While the Budget Bill adopted numerous changes to NYS law, permitting the Department to appeal NYS Tribunal decisions and allowing FCA cases against non-filers will have a material impact and represent a seismic shift in the law for tax litigation purposes. 

DLA Piper can assist with any NYS or NYC tax controversy in the administrative appeals or in further judicial review, as well as in navigating the complex issues of a NYS audit or defense of a purported FCA violation through both procedural and substantive channels.