Sales Tax Slice: Fraudsters Use Phantom Software and Fraudulent Invoices to Cook the Books

Federal tax evasion is a common topic. Turn on the news any given day of the week and you will hear about some celebrity landing behind bars for tax evasion. For example, earlier this year, the owner of Mystic Pizza, made famous by the movie starring Julia Roberts, was found guilty of tax evasion for diverting cash from the restaurant’s gross receipts to his bank account. Not often do you hear about sales tax evasion, although in the last few years it’s become more prevalent with the invention of zappers—phantom sales tax suppression software.

Zappers work by having the user install the software program to a point of sale system from a flash drive.  The program allows the user to modify sales records by deleting transactions and reducing the tax liability on the business.

A couple of large cases involving the use of zappers have made the news- the first in the United States was in the late 90s, Stew Leonard’s Dairy, a company that zapped out over $17 million  over  10 years and La Shish, a chain of Lebanese restaurants out of Michigan, whose owner zapped around $20 million.

State tax revenue departments are left holding the bag when taxpayers fail to report accurate sales tax information and documentation required for refund claims.  The Washington State Department of Revenue supported the passage of the 2013 Senate Bill 5715, unanimously passed by both the House and Senate to combat the spread of zapper software. Bill 5715 makes it a Class C felony to commit electronic tax fraud. In addition to the felony charge, the bill subjects anyone who manufactures, provides, or services zappers to a mandatory fine that is the greater of $10,000 or the amount of tax that was not paid. 

Kentucky legislators in 2014 House Bill 69 made possession of zappers a Class D felony and in California, violators could be sentenced up to three years in the county jail, fined up to $10,000, and be required to pay all illegally withheld taxes including penalties and interest. The BOE estimates sales tax losses to the tune of $210 million each year.

Some craftier, hands-on tax evaders commit sales and use tax fraud by using MS paint and Adobe Photoshop to alter invoices and receipts. Just recently, an employee of Ryan, LLC, a tax services firm with one of the largest transaction tax practice groups in North America did just that. The employee pleaded guilty to manipulating client transactional data and falsifying invoices and other transactional records to inflate the amount of sales and use tax paid by the firm’s clients. The employee, much like a zapper, altered or fabricated the total value of transactions, the products and services purchased in transactions, and the amount of sales and use tax paid on the transactions. This scheme cost the state of Virginia over $19 million in fraudulent refunds, the Daily Tax Report recently reported. 

In the retail sales tax system, businesses act as collection agents for the government and states are unable verify that all of the sales tax collected are actually remitted to the government. Without real oversight, states lose money and fraud becomes harder to detect.

Tax evasion costs millions in revenue for states each year. The longer it takes to discover and unravel the ploys, the greater the likelihood that criminals have moved on to the next big caper. 

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Which is the bigger issue with sales tax fraud, tax evasion or tax theft by parties who collect the tax as state agents?

For more information about state tax issues, sign up for a  free trial on Bloomberg BNA’s Premier State Tax Library.

by Cynthia N. Wells