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

Published by the Government Accountability Office on 2003-06-19.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                            United States General Accounting Office

GAO                         Testimony
                            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
Thursday, June 19, 2003
                            Survey of State
                            Administrators and
                            Contacts with Companies
                            Promoting Tax Avoidance
                            Statement of Robert J. Cramer, Managing Director
                            Office of Special Investigations

             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,

             Page 1                                                           GAO-03-819T
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

• 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.

Page 2                                                         GAO-03-819T
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,

                   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

                 Page 3                                                                         GAO-03-819T
                     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
                     dumping methods, one of our agents placed telephone calls to four firms.
Consultants          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

                     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

                     Page 4                                                            GAO-03-819T
                  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.
                  Cramer at (202) 512-7455 or Paul Desaulniers at (202) 512-7435. Individuals
Acknowledgement   making contributions to this testimony included Jennifer Costello and
                  Barbara Lewis.

                  Page 5                                                            GAO-03-819T
Appendix I


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

                      Page 6                              GAO-03-819T
         Appendix I

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 --

         Page 7                           GAO-03-819T
        Appendix I

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.

        Page 8                            GAO-03-819T
        Appendix I

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.

        Page 9                       GAO-03-819T
        Appendix I


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

        Page 10                   GAO-03-819T
         Appendix I


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

         Page 11                          GAO-03-819T
          Appendix I

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.

          Page 12                           GAO-03-819T
         Appendix I

mean, if I'm just switching out the
employees that are turning over --

         Page 13                      GAO-03-819T
        Appendix I

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 --

        Page 14                           GAO-03-819T
         Appendix I

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 --

         Page 15                      GAO-03-819T
        Appendix I

MR. DESAULNIERS: Okay. I got you.

CONSULTANT # 1: You don't want to
just roll employees.

        Page 16                     GAO-03-819T
         Appendix I

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 --

         Page 17                           GAO-03-819T
         Appendix I

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 --

         Page 18                         GAO-03-819T
          Appendix I

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.

          Page 19                            GAO-03-819T
         Appendix I


CONSULTANT # 1: There's got to be
an additional reason and --

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

         Page 20                     GAO-03-819T
         Appendix I

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

         Page 21                          GAO-03-819T
         Appendix I

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,

         Page 22                          GAO-03-819T
         Appendix I

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.

         Page 23                           GAO-03-819T
        Appendix I


CONSULTANT # 2: But you will
experience some savings.

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

        Page 24                  GAO-03-819T
         Appendix I

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 --

         Page 25                          GAO-03-819T
         Appendix I

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.

         Page 26                             GAO-03-819T
         Appendix I

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

         Page 27                        GAO-03-819T
         Appendix I

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.

         Page 28                             GAO-03-819T
          Appendix I

MR. DESAULNIERS: I mean, is it

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 --

          Page 29                            GAO-03-819T
         Appendix I

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

         Page 30                           GAO-03-819T
        Appendix I

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.

        Page 31                       GAO-03-819T
                    Appendix I

           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

(601115)            Page 32                             GAO-03-819T
This is a work of the U.S. government and is not subject to copyright protection in the
United States. It may be reproduced and distributed in its entirety without further
permission from GAO. However, because this work may contain copyrighted images or
other material, permission from the copyright holder may be necessary if you wish to
reproduce this material separately.
GAO’s Mission            The General Accounting Office, the audit, evaluation and investigative arm of
                         Congress, exists to support Congress in meeting its constitutional responsibilities
                         and to help improve the performance and accountability of the federal government
                         for the American people. GAO examines the use of public funds; evaluates federal
                         programs and policies; and provides analyses, recommendations, and other
                         assistance to help Congress make informed oversight, policy, and funding
                         decisions. GAO’s commitment to good government is reflected in its core values of
                         accountability, integrity, and reliability.

Obtaining Copies of      The fastest and easiest way to obtain copies of GAO documents at no cost is
                         through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-
GAO Reports and          text files of current reports and testimony and an expanding archive of older
                         products. The Web site features a search engine to help you locate documents
Testimony                using key words and phrases. You can print these documents in their entirety,
                         including charts and other graphics.
                         Each day, GAO issues a list of newly released reports, testimony, and
                         correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site
                         daily. The list contains links to the full-text document files. To have GAO e-mail this
                         list to you every afternoon, go to www.gao.gov and select “Subscribe to GAO
                         Mailing Lists” under “Order GAO Products” heading.

Order by Mail or Phone   The first copy of each printed report is free. Additional copies are $2 each. A check
                         or money order should be made out to the Superintendent of Documents. GAO
                         also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a single
                         address are discounted 25 percent. Orders should be sent to:
                         U.S. General Accounting Office
                         441 G Street NW, Room LM
                         Washington, D.C. 20548
                         To order by Phone:     Voice: (202) 512-6000
                                                TDD: (202) 512-2537
                                                Fax: (202) 512-6061

To Report Fraud,         Contact:
                         Web site: www.gao.gov/fraudnet/fraudnet.htm
Waste, and Abuse in      E-mail: fraudnet@gao.gov
Federal Programs         Automated answering system: (800) 424-5454 or (202) 512-7470

Public Affairs           Jeff Nelligan, Managing Director, NelliganJ@gao.gov (202) 512-4800
                         U.S. General Accounting Office, 441 G Street NW, Room 7149
                         Washington, D.C. 20548