Loophole You Can Sail a Yacht Through

By Evan Halper and Richard Marosi

June 30, 2004 12 AM PT

Time Staff Writers

SACRAMENTO — Amid spending projections and tax proposals being exchanged in Sacramento, a surprising document recently cropped up: “The 90 Day Yacht Club Guide to Ensenada.”

It’s a guide to a California sales tax loophole that hundreds of yachts sail through every year, costing the state as much as $55 million.

And it is one of a handful of issues still on the table as lawmakers rush to reach agreement on a $103-billion state budget by the end of the fiscal year at midnight tonight.

Democrats want to kill the loophole to raise money for social services. Republicans want to save it, saying it keeps boating industry jobs in California.

At issue is the state’s sales tax of about 8% -- depending on the county -- on most purchases, including vessels of all kinds. For most boat buyers, the tax is no more than a few thousand dollars. But for boats costing $400,000 and up, many financial advisors say it pays to avoid the sales tax altogether by taking advantage of the loophole in the law. Through it, buyers make their purchases offshore -- and keep the boats out of state for 90 days. After that, they can bring their vessels back to California without paying the sales tax on new purchases.

Tax officials say buyers of planes and luxury RVs are doing the same thing.

To express their disgust with it all, Democrats read aloud from the buyer’s guide during budget talks in Gov. Arnold Schwarzenegger’s office.

“It is just beyond me how they can conceive of defending it,” Assemblyman Mark Ridley-Thomas (D-Los Angeles) said of loophole supporters. “It is as flagrant as they get.”

The book shows wealthy Californians how to harbor their new luxury yachts in Mexico for three months to avoid paying the California state sales tax.

A sample passage: “You may want to use the savings to update the electronics, mechanics or cosmetics on your new boat.... You will find much lower labor rates and fine quality results in the work you have performed while in Mexico.”

Schwarzenegger has expressed interest in the idea of changing the law but remains neutral. He does not own a yacht. A personal jet he partially owns is registered out of state.

Other Republicans want to leave the loophole alone.

Senate GOP Leader Dick Ackerman (R-Irvine), himself the owner of a 42-foot sailboat kept in Long Beach, said that his only regret about the whole thing was that his own boat -- named “Free Ride” -- wasn’t worth enough to bother parking it in Mexico.

“Unfortunately, mine wasn’t that expensive,” he said.

Ackerman said closing the loophole would devastate California’s luxury boating industry. He said it would be difficult to find a single purchaser of a vessel worth more than $400,000 who paid sales tax on the deal. And, according to the senator, they are not about to start.

“When you get to $400,000 or $500,000, it is automatic,” he said. “Nobody in that group takes delivery in California.”

Ackerman said that changing the rules would mean the rich would buy their boats elsewhere.

“You will wind up with a net loss to the state,” he said. “We made a good argument to the governor that it will wind up costing us money.”

Hundreds of Californians follow a fairly simple procedure for avoiding sales tax on their yachts. It starts with them boarding their vessel at least three miles off the coast to make the actual purchase. The transaction is videotaped, so there is evidence to show a tax auditor. The boat is then delivered someplace outside California and kept there for at least 90 days.

In Ensenada, the sleepy Baja California fishing town where three marinas cater to many Californians avoiding the sales tax, people say the impact of changing the law would be traumatic.

The most popular way station for Californians appears to be the Hotel Coral & Marina. The marina provides computer records of maintenance and fuel costs to prove the owners used their boats while in Mexico. Under current tax rules, owners cannot simply leave the boat in storage. It must be in use.

Crews and captains are readily available at the Coral, and slips can be rented for four-month periods. A hot seller in the bookstore: “The 90 Day Yacht Club Guide to Ensenada.”

“The whole reason this marina is here is because of that loophole,” said Victor Sanchez, the marina’s store manager.

Many of the 350 slips on Tuesday were occupied by vessels worth $1 million or more.

“We call this the three-month harbor,” said Ron Johnson of Burbank, while lugging 30-pound albacore tuna off his fishing boat.

Workers at the marina say the owners typically come down on weekends to take their boats out for a sail. Jeff Hamm, captain of a corporate yacht that he estimates is worth $1 million, says escaping the 8% sales tax can go a long way toward paying other expenses.

Just do the math, he says: It’s a savings of $80,000. “That’s your captain and your crew for a year for a boat like that,” he said.

State Board of Equalization Chairwoman Carole Migden, a Democrat, says she finds it all appalling.

“People who buy these yachts bring them in the dead of night and park them in Mexico,” she said. “The rest of us poor schleps have to pay up. We don’t have the option of coming up with these schemes to escape paying sales tax.”

Ackerman calls such characterizations misguided.

“You have to look at the big picture when it comes to fairness,” he said. “How many jobs are created when someone buys a half-million-dollar boat? I would argue a lot.”

If California changes the law, Ackerman said, yacht buyers will simply go elsewhere. He said it would become more economical for millionaires to make their purchases in Florida or Hawaii.

To punctuate that point, he copied a flier for a boat show in Oakland’s Jack London Square and put a big sticker on it that said, “Canceled, moved to Florida.” He handed it to Assembly Speaker Fabian Nunez (D-Los Angeles), telling him that’s what would happen if the law were changed.

Democrats are pushing a proposal that would extend the time a vessel must be out of state from 90 days to a year for the sales tax exemption. Republicans are determined to block that bill (AB 2107), drafted by Assemblyman Lloyd Levine (D-Van Nuys). Democrats want to include it in whatever budget deal is worked out with the administration.

According to the state, no sales tax is paid on more than 1,900 yachts, airplanes and recreational vehicles each year as a result of the loophole.

Some tax preparers say those numbers, as well as the estimate that the state could save $55 million by changing the law, are overblown.

Joe Micallef, chief executive at Associated Sales Tax Consultants in Sacramento, which helps hundreds of clients each year avoid paying sales taxes on boats and planes, says the state’s numbers are “way too high.”

“There are not even that many vessels sold in that period of time,” he said.

Micallef figures the state loses about $10 million in taxes a year through the loophole. “It is minuscule,” he said. “It is not even worth talking about.”

Supporters of keeping the law as it is warn that any changes will have the same unintended consequences as a federal surcharge on luxury items signed into law in 1990. Many say the tax brought in less than half the amount projected and wound up costing much more than that in lost jobs.

“That was just a bigger version of what they are trying to do here,” Ackerman said.

While lawmakers said Tuesday that they were trying to nail down a final budget agreement today, it was likely that they would need several more days to draft the actual spending bills, approve the final package and send it to the governor.

Schwarzenegger spent most of Tuesday in private meetings with his staff and top Democratic and Republican lawmakers, reaching agreement on a plan to shift $110 million to “low-wealth” school districts that have received less per-pupil funding than other districts.

The Senate and Assembly are expected to vote today on gambling compacts that Schwarzenegger has worked out with five Native American tribes. The pacts would allow them to expand their casino slot machine operations in exchange for contributing $1 billion to help solve the state’s budget crisis.

(BEGIN TEXT OF INFOBOX)

Lost revenue

Sales taxes avoided on a $1-million yacht docked in Ensenada, by county:

*--* County Sales tax Los Angeles* $82,500 Orange $77,500 San Diego $77,500 Ventura $72,500

*--*

*Most areas

Source: California Board of Equalization

Halper reported from Sacramento, Marosi from Ensenada.