Act 114, was enacted on June 9, 2005 and amended on April 30, 2009 by Act 32 to close loopholes that permitted “SUTA (state unemployment tax act) dumping”, also referred to as state unemployment tax avoidance. SUTA dumping is a tax evasion scheme involving the manipulation of an employer’s unemployment insurance (UI) tax rate to achieve a lower rate, and thereby pay less UI taxes. SUTA dumping is accomplished through a variety of methods such as transfers of workforce and payroll, restructuring, acquisitions, mergers, and shell transactions.
Hawaii passed this law in response to Public Law 108-295, a federal law passed by Congress and signed by President Bush on August 9, 2004, which established a nationwide minimum standard to curb SUTA dumping and required all states to change their unemployment laws to end SUTA dumping tax evasion schemes. Civil and criminal penalties may also be imposed on persons and advisors who knowingly violate or attempt to violate the SUTA dumping law.
All states use an “experience rating” system to assign tax rates to employers based on their history of unemployment insurance (UI) claims; generally an employer with a large number of unemployment claims will have a high experience rating and a correspondingly high tax rate. Employers who engage in SUTA dumping unfairly shift their costs to other employers causing an inequitable distribution among employers and adversely affect tax rates for all employers, eliminate the incentive for employers to stabilize their workforce, and cost the UI trust fund millions of dollars each year.
The law provides for the following:
- Mandatory transfers. Unemployment experience must be transferred whenever there is substantially common ownership, management or control of two employing units, and one employing unit transfers its trade or business (including its workforce), or a portion thereof, to the other employing unit. Notification of the transfer to the UI Division is required from both parties within thirty days after the date of transfer. The rates of both employing units will be recalculated effective with the calendar year immediately following the date of the transfer. The mandatory transfer requirement does not apply when one employing unit acquires another employing unit and at the time of the acquisition, they are not under common ownership, management or control. The “successor” company still has the option to transfer or not transfer the “predecessor” company’s experience to the “successor” company.
- Prohibited transfers. Unemployment experience may not be transferred, and a new employer rate will be assigned, when a person who is not an employing unit acquires the trade or business of an existing employing unit primarily for the purpose of obtaining a lower rate of contribution. Notification of the acquisition to the UI Division is required from both parties within thirty days after the date of acquisition.
- Penalties for SUTA dumping violations. Any employing unit who knowingly violates the law will be subject to the highest tax rate for the current and following 3 years. If the employing unit is already at the highest tax rate or if the amount of the rate increase is less than 2%, a penalty equal to contributions of 2% of taxable wages will be imposed for the current and following 3 years. Any person who is not an employer who knowingly violates or provides SUTA dumping advice may be subject to a civil penalty of up to $5,000. In addition, a criminal misdemeanor charge with a fine of up to $10,000 may be imposed for each false statement or violation of the law and each day may be considered to be a separate offense.
SUTA Dumping Schemes
Listed below are a few of the tax avoidance schemes used by businesses which are no longer allowed under the SUTA dumping law. Employing units should be aware that these practices constitute SUTA dumping and that there are serious ramifications for disguising the true unemployment experience of a business for the purpose of lowering unemployment taxes.
- Purchased Shell Transaction by Existing Business. A business with a large payroll and a high UI rate purchases a corporate shell and a small payroll is reported each year until a low or minimum UI rate is achieved. Once the low rate is achieved, the business transfers its employees/payroll to the purchased entity. Under the law, the experience of the business with a high UI rate will be transferred to the corporate shell and a rate based on the combined experience will be calculated and become effective the following calendar year.
- Purchased Shell Transaction by a Person Who Is Not An Employing Unit. A person who is not an employing unit purchases a corporate shell with a low UI rate instead of forming a new business solely or primarily for the purpose of obtaining a lower UI rate. Under the law, the corporate shell will be considered a new or newly covered employer and assigned the new employer rate.
- 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. Under the law, the experience of the related corporation will be transferred to the new corporation and a rate based on the combined experience will be calculated and become effective the following calendar year.
- New Employer Rate. An existing sole proprietor or other employing unit with a high UI rate forms and registers a new company with a new employer rate which is lower, then transfers its payroll to the new company. Under the law, the experience of the existing sole proprietor or other employing unit will be transferred to the new corporation and a rate based on the combined experience will be calculated and become effective the following calendar year.
- Partial Transfers of Trade or Business Between Related Companies and Subsidiaries. An existing employing unit transfers employees/payroll or parts of the business to another existing employing unit under the same ownership, management or control. Under the law, experience must also be transferred and rates will be recalculated for both companies and become effective the following calendar year.
SUTA Dumping Guidelines
The applicable section of the law is section 383-66(b) of the Hawaii Revised Statutes. The federal law can be found at section 303(k) of the Social Security Act. To assist businesses in determining whether this law is applicable to their transactions, the following guidelines are provided:
What is an “employing unit?”
An “employing unit” is defined in section 383-1, Hawaii Revised Statutes, as any individual or type of organization, including the State, any of its political subdivisions, any instrumentality of the State or its political subdivisions, any partnership, association, trust, estate, joint-stock company, insurance company, or corporation, whether domestic or foreign, or the receiver, trustee in bankruptcy, trustee, or successor of any of the foregoing, or the legal representative of a deceased person, which has or subsequent to January 1, 1937, had one or more individuals performing services for it within this State.
- (1) All individuals performing services within this State for any employing unit which maintains two or more separate establishments within this State shall be deemed to be performing services for a single employing unit for all the purposes of this chapter.
- (2) Each individual employed to perform or to assist in performing the work of any person in the services of an employing unit shall be deemed to be engaged by the employing unit for all the purposes of this chapter, whether the individual was hired or paid directly by the employing unit or by such person, provided the employing unit had actual or constructive knowledge of the work.
What is meant by “substantially” common ownership, management, or control of two employing units?
The UI Division will examine the facts of each case using reasonable factors. Among other things, consideration will be given to the extent of commonality or similarity of: ownership; any familial relationships; principals or corporate officers; organizational structure; day-to-day operations; assets and liabilities; and stated business purposes.
When is the transfer of trade or business effective?
Generally, the conclusion of an acquisition of trade or business is usually determined by examining the legal documents related to the purchase or acquisition of the trade or business. However, in SUTA dumping cases, an acquisition may not always take place among businesses with common ownership, management or control. If a different entity is issuing paychecks, that may be an indication that there was a transfer of the workforce and the effective date of that transfer.
How are professional employer organizations (PEO) affected by the law?
The same rules apply to PEOs as any other employer. If a PEO sets up a shell corporation and transfers some or all of its trade or business to the shell, then the unemployment experience associated with the transfer must be transferred to the shell.
What factors are considered in determining whether a transactions was made “solely or primarily for the purpose of obtaining a lower rate of contribution?”
Objective factors may include the cost of acquiring the business, whether the person continued the business enterprise of the acquired business, how long such business enterprise was continued, or whether a substantial number of new employees were hired for performance of duties unrelated to the business activity conducted prior to acquisition.
When would penalties be imposed under state law?
Penalties are imposed when individuals “knowingly violate or attempt to violate” or “knowingly advise another person to violate” the provisions of the state law. “Knowingly” is defined in section 383-66 as having actual knowledge of or acting with deliberate ignorance or reckless disregard for the requirements or prohibition involved. “Violates or attempts to violate” includes, but is not limited to, intent to evade, misrepresentation, or willful nondisclosure.
Does the SUTA dumping amendment address situations where one employer reports its payroll under another employer’s account?
No. This practice is commonly called “payrolling” and is already prohibited by state law since it involves an employer submitting false documents concerning who is an individual’s employer for unemployment purposes. If “payrolling” is uncovered, the penalty provision under the SUTA law includes any violation of this chapter and thus, the penalties will apply to “payrollers” as well.