David Duffield PeopleSoft founder accused of evading California taxes
California authorities eventually became suspicious after billionaire David Duffield funded a Nevada real estate development company he formed in 1994 with some of his stock from his California software business.
The investment strategy seemed sound. PriceWaterhouse, which since has become PriceWaterhouseCoopers, said he could minimize taxes by treating the new company as different structures for state and federal filings. But the accounting firm warned that California officials might consider it a scheme.
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They did. Although the California Franchise Tax Board determined that the Nevada company was indeed no sham, it later accused Duffield of evading taxes. The state ordered him to pay nearly $19.7 million, including interest and penalties.
Duffield denied the charges but paid the money as a prerequisite for an appeal. In a complaint filed last month in San Francisco Superior Court, he and his wife, Cheryl, are seeking a full refund.
The Duffields aren't alone in their conundrum. California tax officials say they are investigating more than 270 companies incorporated in the Silver State to determine if they owe the Golden State money.
Most cases aren't as high-profile. Duffield is the software guru who founded PeopleSoft, which was acquired two years ago by archrival Oracle Corp. But his continuing legal battle underscores the state's pursuit of residents with ties to neighboring Nevada.
California is looking at Nevada partly because promoters advertise it as a handy place to stash income. The California Franchise Tax Board suspects some Californians are taking the bait.
But the routine can be as simple as a California business shifting money across the state line to another company that exists only on paper, with no local operations or corporate officers. (Duffield's company did have Nevada operations, buying and developing real estate in the North Lake Tahoe and Reno areas.)
RUSES AND 'CLOAKING SCHEMES'
More elaborate schemes on a larger scale may also involve Nevada. Some shell companies serving as illegal tax shelters have a tangle of tiers tied to various states and even to offshore entities. Promoters sell consumers these prepackaged companies "off the shelf," said Debra Petersen, tax counsel for the California tax board.
"Promoters try to make it difficult to see the ownership chain," she said.
An elaborate ruse may not be necessary. Although most states don't require company owner information, critics say Nevada's lax incorporation laws don't make detection any easier.
When the Internal Revenue Service in November announced its upcoming mass audits of suspected tax dodgers, the federal agency singled out the Silver State -- and Delaware and Wyoming -- as being especially susceptible to fraud abuse.
Those same three states rival offshore financial centers when it comes to offering company registrations with "cloaking features," such as minimal information requirements and limited oversight, according to a year-old federal government report on money laundering.
California officials are quick to point out that it is not illegal to incorporate in Nevada, which levies no income tax on businesses or individuals. But withholding taxes owed to California is indeed illegal.
Companies doing business in California must pay taxes to that state, and Californians must pay taxes on all sources of income, even when it's earned out-of-state.
People living outside California owe that state taxes only on income from California sources.
Just how much money cash-strapped California is losing in Nevada is anyone's guess. But officials there estimate that illegal tax shelters cost the state some $600 million a year. That's just a slice of California's total "tax gap," about $6.5 billion it says it loses annually in all unpaid taxes.
The state has had some success in its collection efforts. Its Voluntary Compliance Initiative, a one-time program aimed at capturing taxes from residents who used tax shelters to illegally reduce their tax bills, pulled in $1.4 billion when it ran in early 2004.
The tax board would not disclose specific details about its Nevada investigations, which are now in the "discovery" phase. But the California controller's office says the money drain could be substantial, if examples uncovered are any clue.
In January, tax board special agents arrested a Modesto orthopedic surgeon on felony charges of tax evasion for allegedly failing to file state income tax returns from 2000 to 2004.
The tax board says Thomas Kaschak owes nearly $138,000 in unpaid taxes on more than $1.6 million he earned during that period. The doctor, who has a home in Reno, reportedly claimed not to be a California resident, even though he had performed more than 1,100 procedures at a Modesto hospital since 1996.
In an unrelated audit cited by Steve Westly, the state's past controller and the tax board's past chairman, a California business paid a contractor $150,000 for work done in that state, yet made the check out to a Nevada corporation.
Petersen said the tax board doesn't know how many California residents who incorporate in Nevada fall into the tax shelter category. She said some may be unwittingly duped by promoters. Others may know better.
"There are some individual investors going into this with their eyes wide open, wanting to avoid or evade taxes," Petersen said. "In some of those cases, in order to obtain the tax benefits from the tax shelter, the investor makes false statements, so there are situations in tax shelters where the investor is as culpable as any promoter."
Promoters usually target taxpayers with high net worth, generating millions of dollars in fees.
Advantages touted
The California tax board in May formed a special unit investigating tax shelter promoters. Since then, the agency has identified about 20 that bear a closer look, including some with possible ties to Nevada.
Promoters aren't the only ones touting the advantages of incorporating in Nevada. The secretary of state's Web site makes a convincing pitch.
Reasons listed online include the state's lack of corporate income tax, franchise tax and personal income tax, and only minimal reporting and disclosure requirements. It also notes the state has no information sharing agreement with the IRS.
"Stockholders, directors and officers need not live or hold meetings in Nevada, or even be U.S. citizens," the list says.
Not much is known about nonresidents who incorporate here, said Scott Anderson, deputy secretary of state for commercial recordings. Only foreign corporations must list their owners.
"There is really no way of knowing how many are from California or any other state," he said.
Only the names and addresses of a registered agent and the company's directors or trustees are required, as are the number and value of company shares. Stockholders' names are not public record.
CLEARING UP THE MURKINESS
Nevada asks for so little information mainly to protect the owners from personal liability, Anderson said.
"There are benefits to being incorporated in Nevada," he said. "Nevada statutes are not designed for illegitimate purposes or tax evasion by any means."
Jack Blum, an IRS consultant who specializes offshore tax evasion cases, doesn't buy that argument.
"The purpose of a corporation is to give people protection from personal liability when they go into business, not to hide who owns the business," Blum said.
"The problem here is the inability to identify the corporations -- the owners or anything about it from state records. That is the way the state presents itself, the way the laws are drafted, and the promoters use it."
State lawmakers, the state Bar Association and the Nevada Registered Agent Association are now discussing ways to dispel some of the murkiness and repair the state's image after the recent IRS characterization.
One issue to be addressed in the current legislative session pertains to so-called bearer shares. A criticism leveled at the state is that it allows corporate stock to be held in bearer form, so that it belongs to whoever possesses it.
That's not entirely true, Anderson said.
"My understanding is that there is no prohibition against bearer shares, but there is no provision allowing them, either," he said. "That is a loophole that the bar association is trying to close."
But clarifying some legal requirements and tightening others may require a delicate touch. According to the resident agent group, about 70 percent of the approximately $87 million generated by the commercial filing division last fiscal year came from "imported filings," or fees for new, renewed and amended filings paid by companies that belong to people outside the state.
"Nevada needs to be careful not to do anything that takes us out of the market, making other states attractive. Then, we do run the risk of losing that business," Anderson said.
"Of course being next to California, we are going to be picked on a little bit. What we are trying to do is keep Nevada friendly and keeping businesses coming in, but we want legitimate ones."
SHARED PROBLEMS
Federal legislation to standardize incorporation requirements would level the playing field, he added.
Since only four states request some ownership information for company formations, it could be argued that most states have exploitable gaps in business formation laws.
That's what irks Derek Rowley, the registered agent association's president, about California's investigation.
"California is critical of Nevada because we don't require ownership information, but neither do they," he said. "The fact that somebody from California comes to Nevada to do business does not imply that they are involved in business activity to avoid paying California taxes.
"You will find that the people using Nevada corporations represent a very broad range of business activity," he said, such as holding patents, trademarks, intellectual properties or titles to other businesses.
Blum, the IRS consultant, said following the paper trail of Nevada corporations ultimately leads to a dead end. Because the state has no information-sharing agreement with the IRS, taxpayer information remains confidential.
"Let's say you discover XYZ Corp. doing all this business," he said. "There is no tax return, then you find out it is incorporated in Nevada. Now you try to track down the company. Good luck."
