Between 1998 and 2008, Thomas Sandell had been earning deferred management fees—through his Sandell Asset Management Corporation, “SAMC”— from overseeing his offshore hedge funds. By postponing receipt of those fees, Sandell was able to defer paying federal, state, and local taxes on that income.
At all times during these tax years, Sandell was a resident of New York State and New York City, and SAMC generated all of the deferred fees it earned from the investment management services it performed in New York City.
In 2008, Internal Revenue Code (“IRC”) Section 457A was enacted and provided that for years thereafter, taxpayers could no longer defer paying taxes on income received from offshore entities, unless that income was subject to “a substantial risk of forfeiture”. Further, 457A required taxpayers who had been deferring income in that manner to recognize and pay taxes on such by no later than December 31, 2017. New York and New York City subsequently amended their respective tax laws to provide that individuals and partnerships who earned deferred fees while in New York City would be required to pay New York State and New York City taxes on those fees whenever they recognized those fees for federal income tax purposes.
As a result of the above-mentioned tax law changes, Sandell sought out the opinions of various CPAs and attorneys. He was advised by an accounting firm that he could reduce or eliminate his New York City tax liability by removing SAMC’s presence and operations from New York City prior to the 2017 tax year (the date by which his previously deferred fees had to be reported for federal tax purposes, and at which point would become subject to tax in New York as well). Acting upon that advice, Sandell: (1) moved to London in or around August 2016 and remained there until 2019; (2) opened a three-person office in Boca Raton, Florida in late-2016, holding out the office as SAMC’s principal place of business to the Securities and Exchange Commission (“SEC”) and to the general public; and (3) arranged for a third-party entity he controlled to make rent and payroll payments for SAMC, even though SAMC remained ultimately responsible for and made those payments.
On his 2017 federal tax return, Sandell reported and paid federal income taxes on the deferred fees that he had earned between 1998 and 2008. However, he proceeded to file his 2017 New York State personal income tax return and New York City unincorporated business tax (“UBT”) return reflecting zero tax liability. Sandell did this despite the fact his prior tax preparers provided contrary advice regarding the elimination of his New York State and New York City tax liability, and after agreeing as part of an unrelated 2017 SEC audit that SAMC’s principal place of business continued to be in New York City (irrespective of the steps he had taken to establish otherwise).
A whistleblower (Tooley, LLC, the individual owners of which declined to be named) sued Sandell under the False Claims Act alleging tax evasion, and this past month Sandell agreed to pay $105 Million in order to settle claims that he evaded New York City and State taxes on the more than $450 million he earned in management fees. As part of the settlement, a portion was paid to the State ($57.03 million), a portion paid to the City ($25.92 million), and a portion paid to the relator/whistleblower ($22.05 million). The False Claims Act provides rewards for flagging fraud on government entities.
State and local tax rules on individual residency and business operational nexus are complex. Proper planning can be an effective tool to save taxes, but receiving the right guidance is important so you are not acting with risk.