Traverse City Record-Eagle

Business

April 4, 2012

States target USB tax cheating

Software keeps two sets of books

THE ASSOCIATED PRESS Associated Press

AUGUSTA, Maine — Cash-strapped state governments that are searching every crevice for money have found a new target: computer programs that enable businesses to keep two sets of books simply by plugging a flash drive into the USB port of their cash registers.

The so-called tax-zapper software lets businesses, especially those that deal mostly in cash, underreport taxable sales and pocket money that should go to the government.

Five states — Florida, Georgia, Maine, Utah and West Virginia — have enacted laws cracking down on the programs, and about a dozen others are considering similar proposals. One expert says states are losing billions of dollars to the software.

"Maine, like all of the other states, has revenues that should be coming in but are not," said Democratic state Rep. Seth Berry, who sponsored one of the measures. "It's our job to make sure that everyone's pulling their weight."

It's always been illegal to cheat on taxes, but the new laws are the first to specifically target tax zappers, making it illegal to possess or install any devices designed to falsify a cash register's electronic records.

The software, which sells for around $500, can be installed directly in registers or through small memory devices that plug into them.

The system works like this: During business hours, cashiers record the true sales and give customers accurate receipts. A log of real sales can also be stored electronically.

But after hours, a memory stick that contains the zapper is inserted to remove a given amount in sales from the day's receipts, say, $500. For each altered transaction, the zapper will also re-total and recalculate the receipt. That changes the tax due and produces a second set of books.

Boston University tax law professor Richard Ainsworth, an authority on the issue, estimates that 30 percent of the predominantly cash businesses in the states are using tax zappers.

The programs are most likely to be found in businesses such as restaurants, where cash volumes are heavy, because transactions using credit or debit cards leave a paper trail. Even by nipping off just a few of the actual sales per day, businesses can reap a considerable illegal reward over time, Ainsworth said.

In some cases, restaurants end up with so much extra money they dispose of it by buying produce or by paying employees in cash "under the table," said Ainsworth. In the latter case, employees sometimes show so little income that they qualify for welfare programs, another burden on states, he said.

The states seem to be awakening to a problem that has been recognized for some time in Europe, Ainsworth said. But the Europeans have a better handle on rooting out cheats because their tax systems are different.

In countries that have value-added taxes — applied to each production phase of a product or service — there's a more unified, comprehensive analysis of how much money is due to the government.

But in the United States, each state has its own tax system, and governments tend to concentrate enforcement on large companies that pay bigger taxes, Ainsworth said. To catch tax zappers, revenue agents have to visit businesses, often small ones.

"You have to dig," he said.

Still, there have been successful prosecutions in the United States. Last year in Detroit, a self-employed computer software salesman who sold a program called Journal Sales Remover was sentenced to a day in jail and two years of probation after pleading guilty to conspiracy to defraud the federal government. Authorities said the program was sold to Detroit-area strip clubs.

A $17 million tax fraud case involving zappers was also uncovered in Connecticut, where authorities found suitcases stuffed with cash while investigating a decade-long scheme at a supermarket chain.

In the restaurant industry alone in California, the loss from zappers was estimated at $2.8 billion three years ago, and in New York at $1.7 billion, Ainsworth said.

Honest businesses take a dim view of competitors who cheat and therefore get an unfair advantage, said Jeff Lenard of the National Association of Convenience Stores, whose constituent stores collect $162 billion per year in various taxes.

"It's about illegal businesses getting a disadvantage over legal businesses," Lenard said. "I don't see many law-abiding retailers who would object" to laws aimed at tax zappers.

Meanwhile, Ainsworth has made it a point to share his knowledge about the issue with policymakers. His presentation at a National Conference of State Legislatures gathering last summer in San Antonio called attention to the problem for the first time, said NCSL policy specialist Max Behlke.

Maine was awakened after looking across the international border at how neighboring Quebec has tracked and tried to neutralize zappers. Quebec revenue officials estimate they lost $417 million in revenue from tax fraud by restaurants during the 2007-08 fiscal year, and the province has gone on to prosecute hundreds of zapper users.

Quebec has taken steps to crack down on zappers, including issuing special recorders to document every sale punched into cash registers.

In New York, a series of sting operations in the last couple of years revealed a scheme in which cash register vendors were invited to pitch their equipment to phony restaurants. In most cases, the vendors offered ways for the restaurants to underpay their taxes, Behlke said.

By Ainsworth's count, at least five other states — New York, Tennessee, Michigan, Indiana and Oklahoma — have drafted bills addressing tax zappers. Massachusetts, Connecticut and Alabama are among others discussing the measures.

Maine's law, signed last month by Gov. Paul LePage, makes it illegal to possess or install an "automated sales suppression device or phantom-ware" designed to falsify the electronic records of a cash register. Installation of such software could bring up to five years in jail and a $5,000 fine. Possession is punishable by up to a year in jail and a $2,000 fine.

Behlke expects more states to take the same steps.

Next year, he said, "we're going to have a huge inundation of these bills."

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