Threatening criminal prosecution in order to collect taxes is used throughout the United States too….

 

You might have seen this story floating around facebook recently. And Everyone has an opinion on it. Legitimate businesses can’t sell pizza in Finland for less than Six Euro for an extended period of time, otherwise those businesses are cheating on their taxes. Finnish police are looking to citizens for tips. (Because – of course – the citizens want to pay more for pizza?)

People seem to think this has something to do with Finland being a “socialist” country. It doesn’t.

tl;dr If you want to do business in Connecticut, make sure you don’t get audited by the Department of Revenue Services. If you get audited, make sure you are ready for it. If you aren’t ready for it, then hire someone to fight for you before the sales tax is assessed. Because after the tax is assessed, it’s game over. And you thought “socialist Finland was bad

And if you are wondering why the Finnish Police are involved, and you think that would never happen here in the states, you are wrong. Here in the states, though, our governments focus on big data instead of crowdsourcing.

For some examples of how this works. I’ll focus on New York, because it’s where I grew up, and Connecticut because it’s where I live and work.:

New York decided it was easier to count pizza boxes than to find rats willing to bite the hands that feed them.

New York’s data mining got some press back in 2010, when Bill Comiskey (who flipped sides that same year, for a good reason, and now defends taxpayers) took some time to speak with the Post-Standard about how he was leading the charge to use third-party data against small business owners and catch them red-handed.  How do state tax departments use third-party data?? Here’s one apt example:

Is a pizza franchise selling more pies than it is reporting to the state? The chain’s parent company might have to show how many pizza boxes it sent to the local shop.

Comiskey, a former prosecutor of mafiosos  also seemingly had a direct impact on NY’s increased criminal tax fraud investigations and prosecutions:

Criminal tax fraud investigations increased from 581 in the ’06-’07 fiscal year to 2,078 in the ’08-’09 fiscal year. Nearly 600 cases were referred to prosecutors that year, about three times as many as the last year of the previous administration.

So New York is both using data collection to catch tax cheats who own pizza places (but perhaps only if they make shameful pizza like Dominos), and pressuring taxpayers with criminal prosecutions when they get caught (and probably only after they don’t pay up.)

[Additional Reading: For some hilarious examples of “non-residents” of New York City achieving mixed results by using their own  data (like phone records, EZ Pass statements, credit card statements, flight logs, and cable bills) to try to levy taxes against non-residents, take a look at this New Yorker article from 2012. (As is true for most kinds of tax litigation, taxpayers have the burden of proving they were not in NYC for more than half of the year in order to avoid being deemed residents and end up stuck paying the city’s Personal Income Tax.)]

The Connecticut Department of Revenue Services is a fan of big data, and criminal prosecutions as well.

Connecticut got into the big data game around the same time as New York. Specifically, Connecticut focuses on retailers that purchase large amounts of cigarettes and liquor from distributors (I presume because this data is easy to process. Or maybe it is just that  liquor stores, bars, restaurants, and convenience stores are likely to be owner operated and likely to have lots of cash transactions.)

The DRS admitted to using third-party data and automated systems its Sales Tax Collection Initiatives Report to the CT General Assembly in 2014. (They like using big data so much they mention it on page 8, and again on page 12.)

Page 8: Advances in technology and the use of data analytics have allowed DRS to improve its ability to identify those taxpayers that are likely to be noncompliant and those most likely to be subject to successful collection.  DRS employs a sophisticated data warehouse that contains elements from internal as well as external sources.

Page 12: Tracking third-party data is helpful in flagging potential tax evasion.  DRS obtains alcohol, cigarette and auto sales data that is then compared to reported taxable sales to produce audit leads. The agency is also beginning a similar initiative using IRS 1099 federal credit card sales data to compare to state reported gross receipts.

But what we really find out from the report is that DRS really likes Puerto Rico’s POS initiative for data tracking. Apparently, Puerto Rico collects data directly from retailers with a one-two-punch by literally offering taxpayers/customers lotto tickets in exchange for their crowd-sourced pressure on business owners:

Page 21: The initiative is referred to as “IVU Loto.” “IVU” is the Spanish-language acronym for the sales and use tax. “Loto” refers to the customer lottery included as a means to induce merchant compliance.  Frequent, low prize value lottery drawings are intended to incent customers to demand that merchants use the system to provide receipts that include the “Loto” number. PRDT holds semi-weekly LOTO drawings awarding one $25,000 prize, one $1000 prize and eight $500 prizes in each drawing.

 

I have seen Connecticut prosecute taxpayers who owed more sales taxes than they could pay on more than one occasion. (I wrote about one of those cases here, but I have seen many more. I was actually genuinely surprised when I was reading the 2014 DRS report and I saw that the amount of arrests made by DRS were so low for 2011-2013: “DRS made 34 arrests in FY 2012-13 and 62 in FY 2011-12 for Sales Tax criminal violations. ” (Yes, the CT Department of Revenue has its own cops.)

I’m sure the numbers were much higher in the past two years. And it is only going to get worse. Why is that? because the DRS convinced the general assembly to pass a law giving DRS the right to revoke Sales Tax Permits. And DRS is pretty excited about it:

 

Page 12: Prior to 2013, DRS routinely renewed sales tax permits for 5 years and cigarette and tobacco products licenses annually – even if the taxpayer was delinquent.  Based on newly enacted legislation initiated by the agency, permits are no longer renewed when back taxes are owed and sellers are advised of the legal penalties for operating without a tax permit.  Permits will only be conditionally renewed if the taxpayer makes payment in full or maintains an approved payment plan.  In addition, after 30 days of further non-compliance, the delinquent taxpayer and the case is referred to SIS for may result in arrest and prosecution. 

Now that CT DRS has such an incredible arsenal of tools to pressure small business owners with, I think that a state-funded POS system is in order (but, let’s leave out the “lotto” part, OK?) And here’s why. Connecticut has some really bad case-law that allows its auditors to run wild with Sales and Use Tax Audits. Let me explain with a not-so-hypothetical illustration:

1. Step One. Overzealous Audit. DRS runs reports it receives from third-party vendors through some computer program it uses to crunch numbers. Based on the amount of cigarettes, and booze reported as sold to a liquor store by its vendor, and the amount of gross receipts reported on that store’s Sales and Use Tax return, the computer flags the business for audit. So the auditor goes down to the liquor store and demands to see the books. Well, under Connecticut precedent, if those books do not include a detailed list of every single transaction, even if daily summary tapes are provided from the actual POS system, then the auditor can basically disregard any records kept by the business and make the numbers up based on the third party data. (It’s worth noting that even in the case, Alexandre v. Commissioner,  that established this precedent, the taxpayer was able to cut his liability by more than half by exercising his due process rights.)
2. Step Two. Wait. Most taxpayers who are subject to a Sales and Use Tax Audit make the mistake of trying to work things out on their own with the auditor. Maybe they get somewhere, maybe they don’t. The audit  might drag on for several months. But eventually, once the auditor is satisfied with her numbers, she is going to close the audit and send a bill. And at that point, the clock starts running on the taxpayer’s appeal rights. If you don’t appeal in time, the assessment will be final – and you no longer have any right to fight the underlying liability.
3. Refuse reasonable payment plans, demand payment in full, threaten criminal prosecution. Once the tax is assessed, it’s pretty much game over as far as the examiner is concerned. The case will eventually move from audit to collection, where tax warrants (wage levies and bank account garnishments) will eventually be issued if the taxpayer does not propose a solution that the DRS agrees with. But wait it’s actually better than that! The thing is that the DRS has such a powerful arsenal now to collect sales taxes, that it no longer needs to actually try to find the money. It used to be that in order to threaten criminal prosecution, DRS had to be creative and charge taxpayers with larceny or it at least had to prove that a taxpayer’s failure to pay or file was willful.. Not anymore. Now all the DRS needs to do is wait. Because once that permit comes up for renewal, DRS. Just. Won’t. Game over.
4. Step Three. Refuse to renew sales tax permits. Actually criminally prosecute.

I could write more. But this post is already too long. So I’ll do the reddit thing down here and up top.

 

tl;dr If you want to do business in Connecticut, make sure you don’t get audited. If you get audited, make sure you are ready for it. If you aren’t ready for it, then hire someone to fight for you before the tax is assessed. Because after the tax is assessed, it’s game over. And you thought “socialist Finland was bad.”

 

For a laundry list of several state’s positive spins on how they are closing the tax gap with the aid of technology, see BNA’s article here.