Closing the ‘tax gap’

OLYMPIA – About 1 in 20 companies doing business in Washington either pay less than their share of state taxes or pay nothing at all, state officials said Wednesday.

All told, they say, tens of thousands of businesses in Washington are underpaying their state taxes by about $457 million a year, due largely to an “underground economy” of service-related employers.

“We know very little about these people” other than that they’re not paying, state Department of Revenue Director Cindi Holmstrom told Gov. Chris Gregoire on Wednesday. Part of the data came from a comparison of firms registered with the IRS but not with the state.

A couple of things researchers do know: Most of the unpaid taxes are from businesses based in other states. Of those based here, many are small, grossing less than $100,000 a year.

Troy Nichols, Washington director for the National Federation of Independent Business, said he doubts that many small businesses are deliberately dodging the law. But the state’s business laws are complex, he said, particularly Washington’s unique business and occupation tax on gross revenue instead of profits.

“You’re talking about operations run literally out of their garages,” he said. “Just to comply with the amount of paperwork it takes to actually have employees is a serious burden.”

The $457 million includes unpaid taxes, workers’ compensation payments and unemployment insurance. Some companies don’t pay enough in taxes; others pay nothing, since they’re not even registered as a business.

State officials are hoping to narrow the “tax gap” with a mix of education, audits and enforcement.

“We’re going to find you … so come on in. The welcome mat is out today,” said Gregoire, who said she first heard about the problem as attorney general. “The last thing we want as a message in this state is that you’re at a disadvantage if you play by the rules.”

For years – including at a state hearing in Spokane earlier this year – business owners have urged the state to crack down on scofflaw competitors. If a company isn’t paying workers’ compensation costs, for example, but one of its workers is hurt or killed, the state still pays. But it means that those who do pay are having to pay extra to cover those costs.

“We hear all the time, ‘We must do something about the underground economy,’ ” said Ernie LaPalm, a deputy director of the Department of Labor and Industries.

A Department of Revenue study in February estimated that there are as many as 164,000 unregistered businesses operating in the state.

Among Washington-based ones – including home-cleaning, lawn care and personal accounting services – about a quarter of the unpaid taxes are due from companies in Eastern Washington. The report recommended that the state focus on the biggest losses: out-of-state companies and those in the Puget Sound region.

“We just don’t want this to turn into some heavy hammer on folks who are filing and trying to follow the law,” said Nichols.

Although Revenue has a “tax discovery team” that investigates unregistered businesses, much of the agency’s work is simply educating small businesses about the state’s tax rules, department spokesman Mike Gowrylow said. Many of the unregistered businesses, the recent report said, are businesses that work in isolation from other firms and professional associations. They may not know that they have to register, or how.

“It (education) is the most cost-effective way to get business registered and paying taxes,” Gowrylow said. The department recovers about $25 million a year from unregistered businesses.

In other cases, businesses are deliberately avoiding registration. Two years ago, for example, the state filed felony charges against a Grant County couple who were allegedly collecting – but generally not turning in – sales tax from their concession and catering businesses. According to state investigators, Joy A. Stewart and Joaquin T. Duzon Jr. repeatedly used other names to keep running their businesses without a license.

The two pleaded guilty to felony charges and were sentenced to probation and to repay about $1,500 in back taxes, plus other costs.

This spring, state lawmakers unanimously voted to launch an “underground economy” task force to scrutinize the construction industry.

The goal: boosting oversight and regulation of what lawmakers believe is a large percentage of unreported construction employees. The group is to make its recommendations at the end of this year.