SUTA (State Unemployment Tax Act) dumping, one of the biggest issues facing the Unemployment Insurance (UI) program, is a tax evasion scheme where shell companies are formed and creatively manipulated to obtain low UI tax rates. When a low rate is obtained, payroll from another entity with a high UI tax rate is shifted to the account with the lower rate. The entity with the higher rate is then "dumped." Such abusive schemes leave other employers making up for the unpaid tax. SUTA dumping is also referred to as state unemployment tax avoidance and tax rate manipulation.

What Harm Does SUTA Dumping Cause?

Under the experience rating system, employers pay unemployment taxes at rates commensurate with claims activities by their employees. Employers with high unemployment activity pay higher unemployment tax rates, and employers with lower activity pay less. Employers who engage in SUTA dumping (or other tax manipulation schemes) to avoid paying their fair share unfairly shift their costs to other employers. SUTA dumping is harmful because it:

• Compromises the integrity of the UI system.
• Results in an uneven playing field.
• Eliminates the incentive for employers to avoid layoffs.
• Adversely affects tax rates for all employers.
• Costs the UI trust fund millions of dollars each year.

SUTA dumping hurts everyone – employers, employees, and taxpayers make up the difference in higher taxes, lost jobs, lost profits, lower wages, and higher costs for goods and services.

SUTA Dumping Schemes

There are several variations on the schemes businesses use to inappropriately lower their UI tax rate. Employers should become aware of these schemes and their potential legal ramifications. Examples of SUTA dumping schemes:

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



2. 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 into this account.



3. New Employer Rate
   An employer with a high UI rate files a registration form requesting a new employer account number, which has a lower rate (new employers pay 3.4% in California), then the payroll is transferred to the new account.



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



5. High Plus High Equals Low
   A high UI rate account with a large payroll is transferred into another high UI rate 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 taxes from the large payroll are added to the reserve account balance as of June 30, resulting in a very low UI rate being established for the next year.



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



7. Partial Reserve Account Acquisition
   A newly registered business applies for a partial reserve account balance of another company. When the small reserve balance is acquired, a correspondingly small average base payroll is also acquired. A related entity then shifts hundreds of millions of payroll into the small account. Because the average base payroll is tallied on a calendar year basis 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.



8. 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. This typically occurs when a labor action is contemplated and temporary workers are hired knowing they will be laid off after the labor action. Another variation on this scheme is when a company is planning to downsize. Employees to be laid off are transferred to a subsidiary account. This buffers the reserve account of the initial company from UI charges.

Is It Illegal?

Employers who engage in SUTA dumping or other rate manipulation schemes knowingly misrepresent facts about their business. It is illegal under California statutes to knowingly make false statements and omit material facts on UI tax documents in order to reduce UI taxes. In addition, new laws have recently been passed to combat SUTA dumping:

• SUTA Dumping Prevention Act of 2004 - Signed by President Bush in August 2004, this law requires each state to enact laws to prevent employers from inappropriately lowering the UI contribution rates. The law not only bans SUTA dumping but also levies heavy penalties on those who engage in or promote such abusive practices.



• AB 664 - With the passage of AB 664, California became one of the first states in the nation to enact legislation as a result of the federal SUTA Dumping Prevention Act. This new law, effective January 1, 2005, provides for employers who are caught illegally lowering their UI rates to pay at the highest rate provided by law plus an additional two percent. The new law also provides for the greater of a $5,000 penalty or 10 percent of underreported contributions, penalty, or interest for anyone knowingly advising another person or business to violate California's UI rate and reporting laws. It also makes changes in the law regarding the application and transfer of UI reserve account balances. It specifies that whenever an employer transfers its business to another employer, the reserve account will be transferred if they are under common ownership, management, or control. The new law also provides that if the acquisition was for the purpose of getting a lower UI rate, the transfer will be denied.

What Is EDD Doing to Fight SUTA Dumping?

The EDD actively pursues and prosecutes employers who participate in SUTA dumping and other tax manipulation schemes and has the authority to subpoena records and individuals in its investigations. In addition, the EDD regularly conducts outreach with employers and tax advisors to ensure they are aware of these schemes and to help them avoid future legal trouble. As a result of our efforts to fight SUTA dumping, the EDD has assessed more than $100 million and has collected an additional $32 million as of August 2004.

How to Report SUTA Dumping

If you think someone is committing fraud or engaging in SUTA dumping, please report it to us immediately. All allegations of fraud are taken seriously. Please provide as much information as you can, including:

• Employer name, address, and telephone number
• Employer account number
• What they are doing
• When they started doing it
• Your name, address, and telephone number (optional)

To Report Fraud

• Call: 1-800-528-1783
• Fax: 916-227-2772

Resources

Information Sheets/Publications

• Information Sheet: California System of Experience Rating (DE 231Z)
• Information Sheet: Unity of Enterprise (DE 231UE)
• Managing Unemployment Insurance (UI) Costs (DE 4527)

California Unemployment Insurance Code

Sections 125-144:
Section 135	Defines "employing unit."
Section 135.1	New employing unit is not created under a vertical unity of enterprise (UE).
Section 135.2	Multiple business enterprises are one employing unit under horizontal UE.
Sections 976-995:
Section 976.5	Voluntary UI contribution.
Sections 1025-1037
Section 1025	The director shall keep separate records of the amounts paid into the fund by each employer.
Sections 1051-1060:
Section 1051	Application for reserve account transfer.
Section 1052	Reserve account transfer does not apply to acquisitions made solely or primarily to obtain a lower UI rate.
Sections 2101-2129
Section 2101.5	It is a violation to willfully make a false statement or representation or knowingly fail to disclose a material fact.


Note: With the passage of AB 664, some of these code sections have been amended effective January 1, 2005. To view the latest applicable additions and amendments, refer to AB 664 .

Other Links

To learn more, type "SUTA dumping" in your search engine or visit the following sites:

• SUTA Dumping Prevention Act of 2004
• California Employer, First Quarter 2004, page 2, "Are you aware of UI rate manipulation?"
• California Employer, Fourth Quarter 2003, page 3, "Beware of Unemployment Insurance rate manipulation schemes"
• U.S. Department of Labor (type "SUTA dumping" in their search engine)
• U.S. General Accounting Office (type "SUTA dumping" in their search engine)
• UI Technology News, May 2004, "California EDD Site Visit"
• Joint Hearing on Unemployment Fraud & Abuse, Subcommittee on Human Resources & Subcommittee on Oversight, Committee on Ways and Means, U.S. House of Representatives, June 19, 2003