The Battle To Preserve An Unbelievable Loophole In New York’s Tax Code

Eight years ago, a whistleblower accused a credit card processor for many of Manhattan’s topflight hotels, including the Waldorf Astoria and the Trump Hotels, of dodging New York state taxes.

The person alleged that the company, POST Integrations, was using the fact that it is headquartered in Arizona as an excuse not to pay New York, despite doing much of its business there. The case went to court.

But instead of battling over the core issue — whether POST Integrations knowingly committed tax fraud — the two sides spent years litigating over whether the company had technically ever lied about it. The company initially argued that it couldn’t be accused of submitting a false record because it never filed that New York tax return. And, in a sense, they were right.

The New York state law that allows whistleblowers to expose tax fraud has what critics say is a glaring loophole that protects the state’s most skillful tax cheats. While filing a false tax return is criminal, the law doesn’t allow whistleblowers to bring an accusation without pointing to a false record.

It remains difficult to prosecute someone who is not paying the taxes they owe but who is clever enough not to leave a paper trail.

“Why in the world should it matter to authorities whether someone committed tax fraud by filing a false tax return or by never filing anything?” asked Gregory Krakower, who drafted the original law more than a decade ago as counsel to the New York attorney general and has fought to close the loophole; he is now an adjunct professor at Cardozo Law School. “If a large, out-of-state company knowingly and improperly pays no taxes and never filed a return, are we going to protect and empower that? It makes no sense.”

But as bizarre as the loophole may be, it has survived multiple attempts to slam it shut. Now, a bill to close the loophole is headed to New York Gov. Kathy Hochul’s desk — with a coalition of the state’s largest business interests lined up in opposition.

A court allowed the case against POST Integrations to go forward in 2017 based on another section of the law, which continues to this day. An attorney for the company did not respond to a request for comment.

The loophole exists within a law that allows the attorney general or whistleblowers to sue wealthy individuals and corporations they believe are committing tax fraud.

New York is the realm of legendary tax cheats, like hotel heiress Leona Helmsley and the ex-corporate titan Dennis Kozlowski. He dodged millions in sales taxes on fine art and spent stolen corporate funds on such extravagances as a $6,000 shower curtain. In 2010, under the shadow of scandals like these, the state legislature updated the New York False Claims Act, an existing law against making fraudulent claims to the government, to include tax fraud.

The new law permitted suits against people or companies with more than $1 million in annual income who allegedly owe at least $350,000. It entitled a whistleblower who brings a successful lawsuit to receive about 20% of any recovered tax revenue.

Large, powerful interests were “apoplectic,” Krakower recalled. And so, in 2013, they fought back when the legislature attempted to amend the False Claims Act again. Lawmakers passed a new provision that made it a crime to “knowingly” defraud the state government, even if the violator never made a false statement or false record — but a group of Republicans inserted a loophole that excepted cases of tax fraud.

Proponents of closing the loophole fear this favors out-of-state corporations. Such as those that do business in New York but pretend otherwise or the wealthy snowbird who files his returns in low-tax Florida but secretly spends most of his time in New York.

“These are not people the tax department could find on their own,” said New York State Sen. Liz Krueger, who chairs the chamber’s finance committee.

Krueger has sponsored a bill, which has passed in the state legislature and is now heading to the governor’s desk, that would close the loophole by making it a crime to “knowingly” commit tax fraud whether or not that involved a false record.

“It is a small, senseless loophole that allows tax cheats to get away with tax fraud by carefully avoiding using a false record or filing a false N.Y. tax return,” Krueger and State Assemblywoman Helene Weinstein, who sponsored the legislation in the general assembly, wrote in a recent letter to Hochul.

A broad coalition of business councils from around the state and an organization representing thousands of employees for the Big Four accounting firms — Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers — have all called for Hochul to veto the bill. She vetoed a similar measure on New Year’s Eve in 2021, echoing their concerns that the bill is too broad and might implicate corporations and accountants unaware they owed state taxes.

Krueger believes this latest version addresses those concerns, noting the bill only criminalizes “knowing” fraud. But the opposition is holding fast.

“Why should we want to be liable for conduct that we don’t know about, or if our client supplies us with fraudulent information?” said Kevin McCoy, chair of the New York State Society of CPA’s legislative task force.

“They should be worried that we’re writing a law where there’s a liability for them,” Krueger said. “Getting it right is what they get paid to do.”

A spokesman for Hochul, Justin Henry, said she’s reviewing the legislation.

Notwithstanding the loophole, the originators of whistleblower law hold it up as a runaway success. Since 2010, New York has recovered roughly $585 million from tax matters. A hedge fund that claimed to be located in Alabama paid the city and state $70 million. In 2018, Sprint settled with New York City and the state for a whopping $330 million in unpaid sales taxes.

Because these fraud claims proceed through the court, they are not bogged down by the interminable delays that face whistleblowers at the federal level, where the IRS handles tips. At the same time, the overall number of cases in New York, about 20 per year, has been modest — proof said Krueger and others, that the cases tend to be high-quality and not the kinds of fishing expeditions opponents of the law once warned about.

Other states have taken notice. Lawmakers in California and Connecticut have attempted to pass a version of New York’s whistleblower statute. The District of Columbia passed a version in 2021 without New York’s loophole.

Krueger and Weinstein’s bill is headed imminently to Hochul’s desk, at which point she will have 10 days to sign the bill, veto it, or allow it to become law.