Unemployment Insurance: Survey of State Administrators and	 
Contacts with Companies Promoting Tax Avoidance Practices	 
(19-JUN-03, GAO-03-819T).					 
                                                                 
GAO appeared before Subcommittees on Oversight and Human	 
Resources, House Committee on Ways and Means to discuss the	 
results of our investigation of the extent to which states have  
found that companies manipulate state unemployment tax rates	 
through a variety of methods in order to lower their unemployment
taxes, a practice known as "SUTA dumping," and of the extent to  
which some consulting firms promote SUTA dumping methods. We	 
conducted our investigation from March 2003 through June 2003 in 
accordance with quality standards for investigations as set forth
by the President's Council on Integrity and Efficiency. To obtain
an overview of the extent of the problem, we conducted a survey  
of unemployment insurance administrators, in the 50 states, the  
District of Columbia, U.S. Virgin Islands and Puerto Rico.	 
Additionally, one of our agents, posing as a business owner who  
was looking for ways to reduce state unemployment insurance	 
taxes, placed telephone calls to four consulting firms we	 
identified through the Internet to determine whether they promote
SUTA dumping techniques. We also interviewed officials of the	 
Office of Workforce Security, Department of Labor to determine	 
how the federal-state unemployment program operates.		 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-819T					        
    ACCNO:   A07217						        
  TITLE:     Unemployment Insurance: Survey of State Administrators   
and Contacts with Companies Promoting Tax Avoidance Practices	 
     DATE:   06/19/2003 
  SUBJECT:   Fraud						 
	     Investigations by federal agencies 		 
	     State law						 
	     Unemployment insurance				 
	     State taxes					 

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GAO-03-819T

                                       A

Test i mony Before the Subcommittee on Oversight and Subcommittee on Human
Resources, Committee on Ways and Means House of Representatives

For Release on Delivery Expected at 2: 00 p. m. EST UNEMPLOYMENT Thursday,
June 19, 2003 INSURANCE

Survey of State Administrators and Contacts with Companies Promoting Tax
Avoidance Practices

Statement of Robert J. Cramer, Managing Director Office of Special
Investigations

GAO- 03- 819T

Mr. Chairman and Members of the Subcommittee: I am pleased to appear
before you today to discuss the results of our investigation of the extent
to which states have found that companies manipulate state unemployment
tax rates through a variety of methods in order to lower their
unemployment taxes, a practice known as "SUTA

dumping," and of the extent to which some consulting firms promote SUTA
dumping methods. We conducted our investigation from March 2003 through
June 2003 in accordance with quality standards for investigations as set
forth by the President's Council on Integrity and Efficiency. To obtain an
overview of the extent of the problem, we conducted a survey of
unemployment insurance administrators, in the 50 states, the District of
Columbia, U. S. Virgin Islands and Puerto Rico. Additionally, one of our
agents, posing as a business owner who was looking for ways to reduce
state unemployment insurance taxes, placed telephone calls to four
consulting firms we identified through the Internet to determine whether
they promote SUTA dumping techniques. We also interviewed officials of the
Office of

Workforce Security, Department of Labor (DOL) to determine how the
federal- state unemployment program operates.

I am accompanied today by Special Agent Paul Desaulniers. In summary,
approximately three- fifths of the state unemployment insurance
administrators informed us that their state laws are insufficient to
combat SUTA dumping and that enforcement efforts to combat such practices
are inadequate. Many of the remaining administrators reported

that their laws and enforcement efforts are sufficient to address the
problem. Other administrators told us that they do not have, or are not
aware of, SUTA dumping problems in their states. Additionally, we found
that three of the four consulting firms we contacted were willing to
assist us in developing SUTA dumping methods for our fictitious business.
The fourth firm suggested that SUTA dumping methods are illegal in most
states and indicated that they were reluctant to engage in this type of
business.

Background The federal- state unemployment insurance program, created in
part by the Social Security Act of 1935, is administered under state law
based on federal requirements. The federal government sets broad policy
for

administration of the program, monitors state performance, and provides
technical assistance as necessary to the states. To finance the program,

states collect unemployment insurance taxes from employers to supply the
unemployment insurance trust fund. When employers underpay their taxes,
states may compensate for these losses by increasing the tax rate for all
employers. Therefore, companies that do not manipulate their tax rates by
engaging in SUTA dumping practices may be effectively penalized by the
SUTA dumping practices of companies that do. Currently, there is no
federal mandate requiring states to promulgate laws to restrict employers
from engaging in SUTA dumping practices.

States use an "experience rating" system to assign tax rates to a business
based on its history of unemployment insurance claims; generally a
business with a large number of unemployment claims will have a high

experience rating and a correspondingly high tax rate. Employers engage in
SUTA dumping when they try to lower the amount of tax they pay by altering
their experience ratings. Some employers lower their experience ratings
using a variety of methods, which include the following, among others:

* Purchased shell transactions. Purchased shell transactions occur when a
newly formed company purchases an existing business that has a low
experience rating and, therefore, a lower tax rate than the newly formed
company would have. Under some state laws dealing with employer
succession, the existing business's low experience rating would be
transferred to the newly formed company.

 Affiliated shell transactions. Affiliated shell transactions occur when
an existing business with a high experience rating forms a number of
additional corporations, transfers a small number of employees to those
corporations, and pays unemployment taxes on their wages until the
additional corporations earn a minimum tax rate. Subsequently, major
portions of the original company's employees are moved to one or more of
the new companies to take advantage of the lower unemployment tax rate,
thereby "dumping" the original company's high tax rate.

Survey Results To obtain an overview of the extent to which these and
other SUTA dumping practices are used throughout the United States, we
conducted a nationwide survey of state unemployment insurance
administrators. 1 More than half of the 50 administrators who responded to
our survey

acknowledged that SUTA dumping practices are, or may be, resulting in a
loss of state unemployment tax revenue. Fourteen states reported that they
have identified specific SUTA dumping cases within the past 3 years, with

losses from these cases exceeding $120 million. The employee leasing
industry- followed by the hospitality and construction industries,
respectively- was most often cited by administrators as engaging in SUTA
dumping practices.

Administrators in 21 states reported that they have no laws specifically
addressing SUTA dumping practices. The remaining 29 state administrators
indicated that they have laws addressing SUTA dumping, but 7 of them felt
that those laws were inadequate. Approximately two- fifths of the
administrators indicated that their states are adequately addressing the
problem or that they do not know of any SUTA dumping in their states. Many
administrators noted that identifying and proving SUTA dumping is a time-
consuming and resource- intensive process. They also cited poor

detection methods and inadequate funding for investigation and enforcement
efforts as obstacles to addressing these practices.

Administrators in 20 states reported that other state laws, often those
dealing with employer succession, adequately address SUTA dumping
practices. These states cite their employer succession laws as protection
against such practices because they require the transfer of experience
ratings from one company to a successor company when ownership or
management is substantially the same. However, DOL advised us that no
states currently have laws prohibiting companies from using partial
transfers of experience rating as a SUTA dumping practice.

The employee leasing industry provides contractor staff to client firms.
The leasing company is usually responsible for the workers' wages and
payroll taxes and may be considered their employer, even though work is
performed at the client firm. Thus, the leasing agency, not the client
firm,

1 We sent the survey to the unemployment insurance administrators in the
50 states, District of Columbia, Puerto Rico, and the U. S. Virgin
Islands. Fifty administrators responded to the survey.

will acquire a higher experience rating if these workers claim
unemployment benefits. Several states preclude this SUTA dumping practice
by holding the client company responsible for unemployment insurance tax
on the employees it leases. However, DOL told us that these laws do not
preclude the client company from subsequently using other SUTA dumping
practices, such as affiliated shell transactions, to lower its tax rate.

Telephone Calls to In an effort to determine whether and how consulting
firms promote SUTA Consultants

dumping methods, one of our agents placed telephone calls to four firms.
The agent posed as a construction company owner having approximately 1,000
employees and doing business in Maryland, Pennsylvania, Delaware, and New
Jersey. He asked each firm contacted about the feasibility of switching
employees to another business entity in order to reduce unemployment
insurance taxes.

One firm representative we spoke with recommended that we spin off part of
our current company and form a new one to obtain lower unemployment
insurance rates. He said that as long as we "have good strategies" and
"have some kind of substance behind it," this practice is perfectly legal.

Another firm representative suggested "moving your employees on paper into
another type of organization to assume a better rate." He stated, "It more
or less becomes kind of a shell game where * you're moving people around
periodically to obtain more favorable rates." The representative

stated that this practice is legal but added, "it becomes more of an
ethical issue."

A third firm representative told us that if employees are simply switched
to a newly created company, the state will transfer the experience rating
of the old company to the new one unless you "misrepresent your company."

Instead, he suggested lowering the rate by merging with another company
that has a better rate.

The fourth firm representative we contacted stated that some people file
for a new tax identification number and move all their employees on paper
over to that new tax number to obtain a lower experience rating. The
representative stated that this is illegal in many states but is allowable
in others if some discernable event occurs, such as an asset transfer or
formation of a new business division. The representative was very cautious

about this type of strategy, however, and said, "If you want that done,
we're probably not your best company."

Mr. Chairman, this concludes my statement. At this time, Mr. Desaulniers
will play excerpts from the tapes of two conversations he had with these
consultants. (See app. I for these extracts.) We will then answer any
questions that you or other members of the Subcommittee may have.

Contacts and For further information regarding this testimony, please
contact Robert J.

Acknowledgement Cramer at (202) 512- 7455 or Paul Desaulniers at (202)
512- 7435. Individuals

making contributions to this testimony included Jennifer Costello and
Barbara Lewis.

Appendi I x MR. DESAULNIERS: Now, do I have to buy another construction
business or - -

CONSULTANT # 1: No, you could do this through - - you know, with your own
internally. You' re going to say, hey, look, we want to separate our costs
internally, we don' t want to, you know, have these costs combined, we' re
going to - - these these - -

let' s say the stable employees or the office employees shouldn' t be
reported and getting killed under these other - - where the union guys are
being reported or where the construction workers are being reported. So we
need to separate them out.

You don' t have to buy another company, but it' s how you create that
company, because the spin- off means there' s going to be a new company
forming.

MR. DESAULNIERS: Okay. CONSULTANT # 1: And that company' s going to have
its own unemployment rate.

MR. DESAULNIERS: Okay. And CONSULTANT # 1: How you establish that rate,
that' s what we do.

MR. DESAULNIERS: But it' s not illegal or anything?

CONSULTANT # 1: No, it' s - - none of it is illegal as long as you have
good other additional strategies behind it.

MR. DESAULNIERS: Okay. But, I mean, if I' m just switching out the
employees that are turning over - -

CONSULTANT # 1: Well, you may want to switch out, you know, some of their
office assets. You know what I mean? Like their computers, they' re the
ones that are using them, the telephones and stuff like that - -

MR. DESAULNIERS: Just to kind of give it the impression that it' s
something

CONSULTANT # 1: Right, of substance, of substance. You don' t want to just
- -

MR. DESAULNIERS: Okay. I got you. CONSULTANT # 1: You don' t want to just
roll employees.

MR. DESAULNIERS: That' s good for next year. What happens if I, you know -
- that rate eventually is going to go back up; right?

CONSULTANT # 1: Yeah, possibly and - -

MR. DESAULNIERS: All right. And what do I do down the road?

CONSULTANT # 1: Well, for the construction employees there' s not much
that can be done. They' re going to be coming in to that company and - -

MR. DESAULNIERS: I mean, can I do the same thing over again?

CONSULTANT # 1: You can, sure, but, then again, if you continually do it,
you need to have some kind of substance behind it.

MR. DESAULNIERS: Okay. CONSULTANT # 1: There' s got to be an additional
reason and - -

MR. DESAULNIERS: You just have to keep making up some reason to

CONSULTANT # 1: Keep, keep justifying why you' re doing it and whether
this year it' s because you want to separate north from south - - hourly
from salary, union from nonunion

CONSULTANT # 2: The bigger area for savings in a construction industry and
a multi- state employer is managing your taxes and understanding if you
have options insofar as, you know, like you had talked about possibly,

you know, moving your employees on paper into another type of organization
to assume a better rate. And it will in fact gain you a better rate, but
it is a temporary fix. Eventually, if you have that same unemployment
claim activity, it will catch up to you.

MR. DESAULNIERS: Right. CONSULTANT # 2: But you will experience some
savings.

MR. DESAULNIERS: Okay. I mean, is that tough to do?

CONSULTANT # 2: Well, more and more employers - - excuse me - - more and
more states are trying to move away from that. It used to be somewhat
common employers would do that, especially in the construction industry,
but more and more employers - -

excuse me - - more and more states are kind of catching on to the fact
that this is what employers are doing. While it is legal, I think they' re
looking to kind of move away from that.

MR. DESAULNIERS: I mean, what is preventing you from doing the same thing
another year or two later?

CONSULTANT # 2: That' s a good question. I mean, it really becomes more of
an ethical issue at that point. It more or less becomes kind of a shell
game where you kind of - - you' re moving people around periodically to
obtain more favorable rates.

MR. DESAULNIERS: I mean, is it legal?

CONSULTANT # 2: It is, it is, but it' s something that, as I said, states
- - and there' s a couple in particular that are - - and none of them ones
that you had mentioned - -

are cracking down on it and where they won' t allow you to do that
anymore. It' s - - what they call it is SUTA number

dumping.

So you kind of dump all your employees into this particular new number to
obtain a more favorable rate. Typically it' s a new employer rate, which
is probably lower than where you are.

You get that more favorable rate. You' re locked into it for a period of
time so your rate won' t increase. But at the end of that period, the
state will then look at what you' ve paid in, what they' ve paid out and
they will adjust it accordingly.

(601115)

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