This is the accessible text file for GAO report number GAO-03-819T 
entitled 'Unemployment Insurance: Survey of State Administrators and 
Contacts with Companies Promoting Tax Avoidance Practices' which was 
released on June 19, 2003.

This text file was formatted by the U.S. General Accounting Office 
(GAO) to be accessible to users with visual impairments, as part of a 
longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov.

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. 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.

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:

Unemployment 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.[Footnote 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, 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 Consultants:

In an effort to determine whether and how consulting firms promote SUTA 
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 Acknowledgement:

For further information regarding this testimony, please contact Robert 
J. Cramer at (202) 512-7455 or Paul Desaulniers at (202) 512-7435. 
Individuals making contributions to this testimony included Jennifer 
Costello and Barbara Lewis.

[End of section]

Appendix I :

[See PDF for image]

[End of figure]

[End of section]

(601115):

FOOTNOTES

[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.