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UI Tax Avoidance—SUTA Dumping

An unemployment insurance (UI) tax evasion scheme called “SUTA dumping” has swept across the states.
This scheme allows employers to pay a lower SUTA (State Unemployment Tax Act) tax rate than their history of layoffs would otherwise permit. SUTA dumping cheats employers and employees that play by the rules, as well as the state.1
SUTA dumping works by foiling a fundamental element of the UI system: that employers who lay off workers pay higher tax rates than employers who do not.
Unemployment insurance is funded through an “experience-rated” tax that ensures individual employers cover their fair share of unemployment costs and generally discourages layoffs. Each employer is assigned a tax rate based on its history of layoffs. Companies that have relatively few layoffs receive the lowest tax rate, or “low experience rating.” New companies get a “new employer” rate that tends to be in the middle of a state’s tax schedule. High-layoff industries or companies pay high tax rates.
States have lost hundreds of millions of dollars to SUTA dumping.
Although SUTA dumping schemes are difficult to track, a U.S. General Accounting Office survey conducted between March and June 2003 found that 14 states had identified SUTA dumping cases in the past three years—with tax losses exceeding $120 million.2 A five-year audit of six leasing companies in the state of Georgia found a loss of over $1.6 million to that state’s UI system caused by employers’ “shell” transactions. This only accounts for the abuses that were actually detected—total losses could be much higher.3
Federal law requires that states prohibit only two forms of SUTA dumping.
A federal law enacted in 2004 requires states to block two common SUTA dumping tactics:
  • Purchased shell transactions—A newly-formed company with a mid-level tax rate buys an existing business that has a low experience rating—not for its business value, but for its lower tax rate. The combined company then transfers all of its employees to the business with the lower tax rate.
  • Affiliated shell transactions—An existing business with high taxes forms a number of additional corporations with new tax identification numbers. Then, it transfers a portion of its employees (such as administrative employees who are rarely laid off) to those corporations in order to get a more favorable tax rate.4
A third form—the misuse of professional employee organizations (PEOs)—is left largely unaddressed by federal law.
Federal law does not require states to block SUTA dumping when companies “lease” their employees from PEOs—which lend workers to businesses to perform long-term work. Leased employees are reported for UI tax purposes to be employees of the PEO rather than the customer firm. Since PEOs pool tax rates of their clients’ employees, they avoid the higher tax rate assigned to high turnover employers.
States can identify and prosecute cases of SUTA dumping.
Texas identified 30 SUTA dumping schemes in 2002, and is seeking to recover $20 million from one of the largest leasing firms in the state. North Carolina is pursuing the first of 17 corporate prosecutions, totaling $57 million in damages. California has identified at least 29 companies with payrolls of between $10 million and $1.6 billion that appear to have engaged in SUTA dumping. Michigan has begun more extensive monitoring for SUTA dumping.
States can adopt strong SUTA dumping laws.
As a result of the 2004 federal law, every state except Alaska, North Carolina, Washington, West Virginia, Wisconsin and the District of Columbia enacted SUTA dumping legislation before the end of 2005. The remaining states will likely adopt laws by the end of 2006. Most states have only written laws that meet federal minimum requirements. SUTA dumping legislation should be strengthened by changing language that bars business transactions for which UI tax rate dumping is the “sole or primary” goal, and instead challenge transactions made “substantially” for a lower tax rate—thus lowering the state’s burden of proof.
States can address the PEO issue.
According to the National Association of Professional Employee Organizations, only 13 states (AL, CT, DE, IA, KY, LA, MA, MS, NE, PA, RI, SC, VT) require PEOs to pay UI taxes at the rate of the client in order to preserve the integrity of the experience-rating system. Pennsylvania’s law was passed in 2005 and addresses SUTA dumping in the PEO context. Iowa’s law permits PEOs to lease employees but requires that employees’ wages be reported under the UI account numbers of customer firms for whom they actually perform services.

This policy summary relies in large part on information from the National Employment Law Project.

Endnotes
  1. National Employment Law Project, “Testimony for U.S. House of Representatives Subcommittee on Human Resources, Committee on Ways and Means,” June 14, 2005.
  2. Report from National Unemployment Insurance Directors’ Conference and Legal Issues Forum, October 20-23, 2003.
  3. Report of the Georgia Department of Labor, 1998.
  4. Robert Cramer, “Unemployment Insurance: Survey of State Administrators and Contacts with Companies Promoting Tax Avoidance Practices,” Testimony before the Subcommittee on Oversight and Subcommittee on Human Resources, Committee on Ways and Means, U.S. House of Representatives, U.S. General Accounting Office, June 19, 2003.
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