RICHLAND -- A Richland cigar store owner says a tax on cigars he ships out of state is unfair, unconstitutional and killing his business.
Rick Ornstein has been wrangling with state officials for eight years about the Other Than Tobacco, or OTP, tax.
The state says he now owes almost $1 million in back taxes, penalties and interest.
And after filing eight appeals, he feels he's running out of options on how to keep his business, The Educated Cigar, afloat. He says the taxes keep him from competing fairly with other cigar sellers that sell their products online or by mail order.
"I'm in a Catch-22," Ornstein said.
Ornstein started his business out of the basement of his Richland home in 1998. At the time, he was working as a technical group leader at Pacific Northwest National Laboratory.
"After 25 years (of being a scientist), I got tired of all the crazy politics, and I started doing my own business," he said.
He ordered cigars from about 30 manufacturers and distributors, most of them in Miami. He repackaged them to offer customers a variety of cigars and sold them almost solely to people out of state.
He said his gross sales grew at about 400 percent a year. "We went crazy," Ornstein said.
"In 2001, I decided to leave my day job," he said.
But two years later, the state Department of Revenue audited the business' tax returns and told Ornstein he should have been paying the OTP tax.
The state tax is for the sale, handling and distribution of cigars, pipe tobacco, chewing tobacco and other forms of tobacco, except cigarettes. It's owed by the first seller of the product in the state.
The Legislature generally sets the tax rate and the money collected goes into the general fund. The state collected $30,278,000 in 2009.
Ornstein contends the information he found on the department's website when he started his business, as well as on tax forms he filed every year, led him to believe the tax applied only to in-state sales.
When he started, the OTP tax was 75 percent of the wholesale price of a cigar. That was raised in 2001 to 129 percent, but was later reduced.
The rate changed again in 2010 to a maximum of 65 cents.
By May 2003, the Revenue Department said Ornstein owed $383,905 in taxes plus interest.
In 2006, the department tacked on another $405,820 for back taxes, interest and penalties.
"I was shocked," he said.
State officials agreed in 2006 not to start collection activities during Ornstein's appeals if he agreed to pay $1,000 a month toward those assessments. He also had to agree to start paying the OTP tax on his out-of-state sales.
In the meantime, Ornstein appealed his tax bill to the Revenue Department and then the state Board of Tax Appeals. He later hired a Seattle law firm, Perkins Coie, to continue the fight.
But he couldn't afford to continue to retain the law firm, so Ornstein argued his own case to revenue officials and the tax board four more times.
Last month, the tax board sent Ornstein a letter saying he no longer has any appeal options.
And several days later, he received a letter saying the Revenue Department plans to audit his records.
Ornstein claims the state's website and tax forms should have more clearly stated he had to pay the tax on out-of-state sales.
But the state maintains he should have read the state laws referred to on the website. And if he had questions, the state says, he should have sought legal help or asked state revenue officials.
Ornstein also argues the OTP tax violates the commerce clause of the U.S. Constitution, which among other things limits a state's ability to impose taxes that put up barriers to interstate commerce.
He argues the OTP tax limits his ability to compete in interstate commerce because cigar retailers in other states, including Oregon and California, do not pay a similar tax.
That means his cigars are more expensive for out-of-state buyers. Also, his customers in those West Coast states still have to pay their own state's tobacco taxes to buy his cigars.
"How can I stay in business?" Ornstein said.
Washington consumers who buy cigars from other states also are not required to pay Washington's OTP taxes, which Ornstein said makes it cheaper for them to buy cigars from out-of-state than from him.
"They come in here and buy a few cigars, decide what they like and then they buy the rest on the internet, tax-free," he said.
But state revenue officials see it differently.
"I think it's pretty fair to say we don't agree with him," said Mike Gowrylow, spokesman for the Department of Revenue.
The Board of Tax Appeals says the tax is a possession tax on The Educated Cigar's handling of the cigars, and it's not double taxation if out-of-state buyers also have to pay their own sales or use taxes.
"(The tax) is a cost of doing business that could be recouped in the selling price," said the board's decision.
"Honestly, we don't think he's right, and the law is what the law is," Gowrylow said. "The ultimate solution is to go to the Legislature and ask it to change the law."
Ornstein has tried that.
State Sen. Jerome Delvin, R-Richland, introduced a successful bill in 2005 that reduced the tax. But another bill he introduced that year to allow Washington cigar sellers to claim a credit for the OTP tax if they sold cigars out of state failed.
"I think we had some hearings, but it didn't get through the process," Delvin said.
Ornstein filed a complaint in U.S. District Court in Richland in September 2007, but it was dismissed because he didn't have a lawyer. And he said he's been told that to fight the case in federal court could cost millions of dollars, which he says he can't afford.
* Kathy Korengel: 509-582-1541; email@example.com