No more dumping: State Unemployment Tax Avoidance needs to stop

California CPA, Sept, 2004 by Bruce C. Allen

SUTA dumping, or State Unemployment Tax Avoidance, typically involves the creation of a new business entity and the transfer of payroll between the old and new entities to reduce unemployment insurance rates.

President Bush recently signed H.R. 3463, the SUTA Dumping Prevention Act of 2004, which is designed to discourage SUTA dumping. The new law requires states to conform as soon as possible and it's likely California will conform sooner, rather than later.

H.R. 3463 creates safeguards to prevent employers from transferring or acquiring businesses simply to avoid higher unemployment insurance rates.

Businesses that engage in SUTA dumping--or attempt to--can expect "meaningful civil and criminal penalties" to be imposed. These penalties also will apply to individuals or businesses who advise others to engage--or attempt to engage--in the manipulation of unemployment insurance rates.

According to U.S. Labor Secretary Elaine L. Chao, "America's unemployed workers and the integrity of the system depend on all employers paying their fair share of unemployment taxes. It's simply not fair to workers, or to the vast majority of employers who play by the rules, for a few unscrupulous employers to set up shell companies to avoid paying their fair share."

How it Works

California's Experience Rating System determines each employer's tax rate by accounting for direct benefit charges; contributions paid in; average size of payroll; and any non-charged benefits or socialized costs.

The California Unemployment Insurance Code prohibits an employer from obtaining a new Employment Development Department account number or using another employer's account number to get a lower rate.

The EDD estimates that underpayments to the state's UI fund due to SUTA dumping are in excess of $100 million.

According to Carl Camden, president of Kelly Services, states borrowing from the federal Unemployment Trust Fund has resulted in a steady depletion of the $52 billion fund balance in 2000 to $17.4 billion today.

EDD Springs into Action

The EDD is aggressively pursuing the identification and review of businesses suspected of UI rate manipulation. Schemes on their radar screen include:

Purchased Shell Transaction -- A business with a large payroll and high UI rate purchases a corporate shell with a low UI rate and transfers its payroll to the purchased entity.

Affiliated Shell Transaction -- A new corporation is registered and a small payroll is reported each year until a low or minimum UI rate is achieved. Once the low rate is achieved, large payroll amounts from another related corporation are transferred to this account.

New Employer Rate -- An employer with a high UI rate files a registration form requesting a new employer account number with a lower rate, then transfers an existing payroll to the new account.

Reporting Under a Client's Employer Account Number -- An employee leasing company or professional employer organization (PEO) with a high UI rate will shift its payroll to the account number of one of its clients with a lower UI rate.

High Plus High Equals Low -- A high UI-rated account with a large payroll is transferred into another high UI-rated account with a small payroll at the beginning of the year. Since the calculation of the average base payroll is on a calendar year basis, only the small payroll is considered. However, the contributions from the large payroll are added to the reserve account balance as of June 30, resulting in the minimum or very low UI rate for the next year.

Payroll Parking -- Two unrelated businesses negotiate for a fee to have all or part of the higher UI-rated employer's payroll "parked" in the other's account and reported at the lower UI rate.

Breaking out clients from a PEO and then re-embracing them three years later -- An employee leasing company or PEO with a high UI rate registers all of its clients separately with new account numbers and after three years, when the rates go up, brings them under a new PEO with a new rate.

Partial reserve account acquisition for the purpose of minimizing the average base payroll -- A newly registered business applies for a partial reserve account balance of another company. When the small (2-4 percent) reserve balance is acquired, a correspondingly small average base payroll is also acquired. A related entity then shifts hundreds of millions of payroll dollars into the small account. Because the average base payroll is tallied on a calendar year and reserve accounts accumulate quarterly, the result is to flood the reserve balance in relation to the small average base payroll. A minimum rate is attained in the succeeding year.

Buffering potential negative reserve account charges -- A company that hires temporary workers forms a new entity and obtains a separate account number. The temporary workers are paid through this account. When they are laid off and file UI claims, the newly formed company goes out of business and the negative reserve account charges get distributed to other businesses in the state.