Recently, the State Auditor released Report No. 18-19, which reviewed special funds, trust funds, and trust accounts of our Department of Land and Natural Resources.

Under law, the Auditor is supposed to review an agency’s special, revolving, and trust funds every five years.  The review is supposed to find accounts that are not appropriately classified so that appropriate action can be taken.  Why?  Back in the bad old days, agencies had little pockets of money all over the place that only they knew about.  Our legislators, who are supposed to be watching the money the agencies spend, couldn’t do their job because they had to track special fund dollars hidden in hundreds of nooks and crannies as well as the general fund moneys that the agencies were getting.  So, legislators came up with some sensible criteria written in law, such as one that says special funds need to be self-sustaining, and sent the Auditor to ferret out the funds that didn’t conform to the rules.

Apparently, DLNR doesn’t seem to have gotten the memo.  It butted heads with the Auditor over several of the funds.  Typically, the arguments went like this:

Auditor:  Let’s now turn to the beach restoration special fund.  The fund is self-sustaining, but the program supported by the fund can be successfully implemented under the general fund appropriation process.

DLNR:  The importance of this account cannot be overstated.  We need to protect our beaches!  If we don’t have this fund, our efforts to support beach restoration projects will be severely compromised.  The program should be specially funded because we get funding from Transient Accommodations Tax, and there is a strong connection between the tax and beach protection.

Auditor:  How about the administratively established Conservation and Resources Enforcement fund (which, by the way, is not the same as the Conservation and Resources Enforcement Special Fund)?  It generates no revenue, so it clearly isn’t self-sustaining.

DLNR:  But it gets transfers from the Boating Special Fund to support marine patrol!  It’s used to supplement the general funding for personnel services.  Maintaining this account is important to the Division’s focus in marine patrol efforts.

Are the folks at DLNR even listening to what the auditor is saying?  The loss of a special fund isn’t the end of the world.  People who are paid out of the special fund can be paid out of the general fund instead.  Nobody is going to die or be fired.  The programs that were there before can continue if there is justification for them, which, given their importance, should be easy to establish, right?

Again, the object of this exercise is not for the Auditor to come to the department with a program-chopping axe.  It’s for everyone involved to understand where the money is.  It’s about lifting the veils and promoting transparency, not about swinging the budget machetes through the marshlands.

DLNR needs to understand that the money in these funds isn’t “their” money.  It’s taxpayer money.  If they as an agency do good and necessary things, the public and our legislators will have no problem with their use and stewardship of that money.  Legislative oversight of that money isn’t just an inconvenience, it is a constitutional requirement.  Once our government agencies understand this, all of us will be better off.

We continue with our series about a timeshare association suing Maui County seeking to invalidate its “Time Share” property classification, with the county then striking back.

This week, we look at whether the property classification challenged was valid.

The circuit judge on Maui’s conclusion was that it wasn’t.  He concluded that under section 3.48.305 of the Maui County Code, the “County may consider only the actual use of real property when creating a real property tax classification; it has no authority under the MCC to consider anything else.”

That code section, however, says that land and buildings are classified upon consideration of the real property’s highest and best use, and then lists some exceptions.  It also says that condominium units are classified upon consideration of actual use, and then lists definitions, one of which a definition of the Time Share classification.

First, we need to notice that actual use and highest and best use are completely different.  Highest and best use primarily depends on zoning and has nothing to do with the current owner is currently doing with the property, which is actual use.  So, someone running a farm in the middle of an industrial district would have a “highest and best use” as commercial property but “actual use” as agricultural property.

Next, the tax code is riddled with classifications, credits, and exemptions that have nothing to do with actual use.  I group all three of these devices together because they all assign financial consequences – an owner or renter pays more tax or less tax – depending on whether certain conditions are met.  All counties have such devices that depend on use, and they also have those that don’t.  For example, all four counties exempt “kuleana land,” which depends on whether its owner is a lineal descendant of the persons who received original title from the Kingdom of Hawaii.  All four counties exempt property owned by disabled veterans, persons affected with leprosy, and persons with impaired sight or hearing or totally disabled, which are not uses of the property but medical conditions of its owner.

Of these, the latter three exemptions were carried over from when the State was administering the property tax, before the 1978 Constitutional Convention.  This is significant because when the Convention recommended, and the voters approved, transferring the property tax power to the counties, there were constitutional provisions that required all counties to keep the basic structure, rates, and exemptions then in place for eleven years.  Those exemptions, therefore, were specifically approved in our constitution – and they didn’t depend on property use.

If it were held that differences in real property tax liability must depend only on property to use to be valid, what would happen with the exemptions, credits, and credits on all four counties?  And what would happen with the “Residential A” property classification here in Honolulu, which kicks in if a property doesn’t qualify for a homeowner’s exemption and is valued at $1 million or more?  Homeowner classification is based on use, but valuation of a parcel clearly isn’t.

Ultimately, of course, the higher courts will decide the validity of the Maui real property tax classification system.  The job isn’t easy, and the arguments we’ve made here might turn out to be completely wrong.  But they will give us things to think about while the parties are considering what to argue and while the courts will be mulling over this case.

We continue with our series about a timeshare association suing the county, with the county then back assessing the association for $10 million.

Here we examine:  “Are back assessments of property tax legal?”

In most of our counties, the ordinances say that the assessor is to make a tax assessment list each year by a certain time.  The county then sends out bills to the property owners with the numbers off the list.  Owners then either pay, or appeal.

But what if your property isn’t on the list?

This can happen very easily if you have just signed a lease for state lands.  The state doesn’t have to pay real property tax because governments generally don’t tax each other, so there is no previous assessment of the land.  A lessee of state lands, however, isn’t a government and therefore needs to pay real property tax.  But let’s say, for whatever reason, the real property tax bill doesn’t come in the mail for a couple of years.  The ordinances call that “omitted property,” and they say that the county can assess the current year, and any back years, whenever the county gets around to doing that.  And when they do, if you want to appeal the assessment you need to do it within 30 days – which isn’t much time.

If you go to the county and say that the assessment is unfair and illegal, you won’t get much sympathy.  “You’ve received fire and police protection, trash pickup, and many other benefits that come with occupying that property,” they’ll say.  “Didn’t you think it strange that you were receiving all these valuable benefits for free while everyone else in the county has to pay for them through their property taxes?”

As it turns out, there is a court case holding that this type of assessment, called an omitted property assessment, is perfectly legal.

In our Maui case, however, the facts were quite different.  The plaintiffs were time share associations.  The county had assessed the property – but they didn’t assess the intervals or the condominium units, they assessed the master parcel.  The county sent the bills to the associations, and the associations paid the assessments in full.

“Oho!” the county said.  “We didn’t assess the intervals, which are the units of property that are being bought and sold.  They are therefore omitted property, and we get to assess them whenever we want!”

So, the county back assessed the interval owners, and they assessed a lot more tax because the method they used to assess the master parcel was based on its cost while the method they used to assess the intervals was based on market value.  But then they needed to figure out what to do about the payments that already had been made on the property.  And they decided to credit each of the interval owners for a proportionate part of the payments that were previously made.

Fair, perhaps; but it was also an admission that tax previously had been paid on the property assessed, so the county had no business calling it omitted property.

“[I]f the County can retroactively assess already-assessed real property to change the valuation and impose additional taxes, even many years later as it argues it can here,” the Maui judge wrote, “property owners can never have confidence that they have satisfied their tax obligation for any previous years.  Potential buyers can never have confidence that a purchased property will not later be burdened by a hefty ‘amended assessment’ for some year long before their purchase.”

Well said, Judge; now we’ll see how well his judgment fares in the appellate courts.

In last week’s article we gave some background about a case working its way through the court system.  Timeshare association sues county; county then back assesses association for $10 million.

The first issue for our deep dive is, “Are we in the right court?”

In this state, if you have a beef with the tax collector you can’t just go suing in any old court.  We have a special court called the Tax Appeal Court that hears disputes about state taxes and county taxes.  Tax is complicated, so it makes sense to have a specialist court.  It also helps to limit the government’s downside risk because, while normal courts can have juries, issue injunctions, and award damages, the Tax Appeal Court can’t.  It’s limited to adjudicating the validity and amount of a tax assessment without a jury.  So, if the court thinks the tax people have been bad and need to be punished, there’s nothing that court can do.

For most tax appeals, there are two avenues to court: “assessment and appeal” or “payment under protest.”

Assessment and appeal means the taxpayer must file its paperwork within a certain time after the tax authorities issue their bill.  For state tax, this can be done without paying first.  For county tax, the taxpayer needs to pay to play.

Payment under protest means that the payment must be submitted with a letter of objection, and then the taxpayer must sue in Tax Appeal Court within a certain time after payment.  Payment under protest is available only for state tax.

Now, our Maui timeshare association sued in Circuit Court, which is our court of general jurisdiction.  It went down neither the “assessment and appeal” nor “payment under protest” route.  Perhaps they wanted to get a ruling that the Time Share classification was invalid and might not have seen the law forbidding declaratory rulings in tax cases.  But it turns out that although most tax cases need to be in Tax Appeal Court, there are cases in which the circuit court took jurisdiction.  The appellate courts took note of them but haven’t ruled on whether jurisdiction was proper.

Once the county struck back, however, the dynamic changed.  The taxpayers claimed that they had been denied their federal constitutional rights such as due process, equal protection, and the right to petition the government for redress of grievances (i.e., sue).  There’s a federal law saying that someone whose constitutional rights have been violated by people claiming to enforce state law may sue for damages and attorneys’ fees.  And a state or local government can’t get away from the consequences by shunting the claim off to a specialized court that can’t award damages.  Thus, that part of the case needs to stay in Circuit Court.

The case has already spent five years in Circuit Court, with oodles of resources already spent on it by both sides as well as the court system itself.  It would be grossly inefficient to have a new court start on this case from scratch, so it would make sense to leave the case where it is.

But at the same time, we can’t be using the circuit courts to upset the system carefully created to handle the special circumstances that tax disputes present.  If there are appeal deadlines, they need to be followed.  If there are procedures required, they need to be observed.  If any party thinks they can waltz into court, get a ruling that a tax classification is void, and thereby open the floodgates for anyone who has ever paid that tax to get massive refunds, that party needs to think again.  One of the reasons for the special tax courts is that governments need to be able to operate and can’t do it if they are threatened with financial extinction because of missteps they may have made years or decades before.