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Hawaii’s Underground Economy

Unreported cash-only deals add up to $1 billion a year in unpaid taxes

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Enforcement

The state’s criminal tax conviction rate has been 94 percent over the past 15 years, but Hironaka says most tax-evasion cases never go to trial. Over the past decade, Breiner says, he’s defended only a handful of cases, not because tax evasion is rare, but because violators usually settle out of court.

An investigation normally starts with a notice in the mail or a knock at the door from a government agent. Typically, the IRS comes to collect first, then the state investigates by subpoenaing your business records and conducting interviews. If the state decides to press charges, a guilty plea will result in a fine and/or jail time. Plead not guilty and the case goes to trial – but that’s only happened five times in the past 15 years.

Although TV ads often say, “We can settle your tax debt with the IRS for pennies on the dollar,” Breiner says that’s rare and cautions people not to expect any sympathy from the federal or state governments.

The government will do whatever it takes, just short of throwing you out of your home, to get its money, he adds. However, the government also considers whether or not it’s worthwhile to fight a drawn-out court battle to collect the full amount versus settling quickly for less. “In my experience, they try to work with people who have jobs and are making an honest effort to pay them back.”

Hironaka has mixed feelings about punishment. He believes the penalties are stiff enough but that judges aren’t consistent in their sentencing. For example, he’s seen assault cases end in probation while white-collar criminals get jail sentences. But an attorney who didn’t pay his GET for five years was only ordered to pay $2,500. For that attorney, Hironaka says, the small fine was just part of the cost of doing business. “There aren’t enough deterrents, from our perspective, for people not to cheat on their tax returns, because, if they get caught, they just have to pay a small fine and move on. The (potential) penalties are appropriate but the enforcement is the challenge.”

Tax investigations are often prompted by public complaints when, for example, a contractor does shoddy work and refuses to fix it. Hironaka says disgruntled former employees, competing businesses and ex-spouses also frequently file complaints about tax evaders.

“People also get into trouble when they brag about things,” Hironaka says. “So if you cheat on your returns, it might be a good idea to keep it to yourself.”

The state also relies on computer matching to detect false reporting and filing errors, and to ensure people who are required to do so file both their income and GET returns. In 2005, the state prosecuted 15 real estate agents for underreporting or failing to pay GET.

One of the biggest cases ever investigated in Hawaii started when a tax agent saw a man driving a luxury vehicle and decided to research the driver. “The agent ran the car’s plates and found out the guy was driving a $100,000-plus car and was only claiming a percentage of that for income so the numbers didn’t match up,” Hironaka says. “The point of the story is that we’re ever-vigilant.”

    Illustration: istock.com

Hironaka and his team of criminal tax investigators might be ever-vigilant, but they’re also under-funded. Four people handle all criminal tax investigations for the state and prosecute 30 to 40 tax cases a year. From 1996 to 2009, the courts have assessed $2.3 million in fines and are in the process of collecting $25 million in delinquent taxes.

A new law last year gave the state Tax Department more resources and tools to investigate suspected violations, but the original plan for nine positions was reduced to three by budget cuts. Ronald Randall, state taxation compliance administrator, says the new unit has focused on cash-based businesses that have underreported their tax liabilities. So far, the group has combed through Fort Street Mall, Aloha Tower, Chinatown and other areas.

Randall says the unit receives about 10 complaints a day from the public and has investigated about 200 cases, from auto repair shops to beauty salons, and has assessed about $4 million in underreported taxes.

“People who cheat are most likely going to do so until they’re caught,” he says. “Our goal is to be vigilant and put out as many deterrents as possible to motivate people to comply with the rules.”
Due to limited resources, the tax department rarely investigates illegal activities such as prostitution, gambling and drug sales because the cases are much harder to prove. “We don’t have the resources, manpower or time to do undercover investigations, although we wish we could,” Hironaka says. “Besides, there are so many legal businesses not paying their fair share that we don’t have time to go into the illegal sector.”

 

    Photo Courtesy of Department of Taxation

The Tax Gap

State tax director Kurt Kawafuchi says the national tax gap – the amount of owed taxes that go unpaid – has been estimated to be about $400 billion.

“As a rule of thumb, we usually use one-half of 1 percent to calculate Hawaii’s portion of the tax gap. Experts have said the cash economy is about half of the tax gap so you do the math.”

That means Hawaii’s tax gap is $2 billion a year, and half of that is attributed to the cash economy, $1 billion.

 

    Photo: istock.com

The Main Reason People Cheat

People cheat on their taxes for a variety of reasons: Some actually don’t have the money, others just don’t want to part with it and many do it because they believe they won’t get caught. David Callahan, author of “The Cheating Culture: Why More Americans Are Doing Wrong to Get Ahead,” says many people assume that the most common gripes are that taxes are too high or complicated, but, actually, the biggest complaint is that the rich don’t pay their fair share. Callahan separates people into two main groups: the winning class and the anxious class. The winning class is made up of the wealthy and the anxious class consists of people who struggle financially.

Some people in both groups cheat, he says, but members of the anxious class do it mainly because they believe the rich have the tools to evade taxes and aren’t paying their fair share.

 

    Photo: istock.com

Mr. Contract Hire

“My previous employer is the king of hiring contract workers,” says a former assistant at a small manufacturing company, who asked not to be named. “The funny thing is, most of them aren’t contract hires; they’re full-time employees just being paid under the table.”

Mr. Contract Hire’s company employs about 10 full-time employees, half of them paid in cash. They all work at least 40 hours a week on-site, which disqualifies them from being independent contractors. “I worked for him for four years and he did this the whole time to get out of paying payroll taxes, workers’ comp and medical,” the former assistant says.

Mr. Contract Hire’s jobs pay minimum wage, so many candidates are uneducated and many receive government assistance. He normally offers these prospective employees two options:

• They can get paid $7.25 an hour and receive full medical coverage, but he emphasizes that the government will take one-third of their income for taxes; or

• If they don’t need medical benefits, they get paid $8 an hour cash, tax free.

“He knows that a lot of the workers are covered by Quest medical insurance, and so are their kids,” the assistant says. “If Quest finds out the person is employed full time and being offered medical benefits, it would jeopardize their chances for receiving coverage.”

By choosing the second option, the employee takes home more pay while still qualifying for government assistance, while Mr. Contract Hire saves on taxes and insurance. The company has been audited several times and, although the auditor discovered that Mr. Contract Hire was lying about his workers, he received nothing more than a slap on the wrist.

 

Penalties for Evasion

For each year that you evade your state taxes, the penalty is up to a $100,000 fine and five years in jail. The government could also seize property and liquidate your assets.

 

The $10,000 Tell

Veterans of the underground economy know that lots of cash raises red flags at banks. By law, U.S. financial institutions must file a Currency Transaction Report for each deposit, withdrawal, currency exchange or other transaction of $10,000 or more.

Most bank systems automatically create a CTR electronically and bank employees can note if they believe the transaction is suspicious or fraudulent. Customers are not told about the $10,000 threshold unless they ask, and once the transaction begins, they cannot reduce the amount to prevent a CTR. In fact, an attempt to “structure” their transaction to an amount near, but not over, $10,000 is punishable by federal law and may prompt bank personnel to closely monitor their account.

 

Taxpayers Beware

State criminal tax investigator Stephen Hironaka says the state knows that many tax preparers file false returns on behalf of their clients. “You hear about it all the time,” he says. “A friend will tell you, ‘Go to this person and you’ll get a big return.’ ”

If caught, that preparer will be penalized and the taxpayer will have to pay the correct tax. Hironaka says the longest jail term ever secured by the state was 10 years on a tax preparer who filed false returns for an entire family.

Hironaka’s advice: If someone else prepares your taxes, be sure to check the return for anything that seems suspicious. If your refund is significantly higher or lower than the previous year and your employment situation hasn’t changed, be wary.

 

Report Violators: Call the state Tax Department’s hotline at 587-1456 to report suspected violators. Tips can remain anonymous.

 

Month of Forgiveness

Last year, from May 27 to June 26, the state let eligible taxpayers pay back taxes while avoiding penalties, with 50 percent less interest and the potential to avoid criminal prosecution. Here’s what the Tax Fresh Start Program accomplished:

$14.4 million collected;
$4.2 million in GET;
$3.9 million in income tax;
870 taxpayers
participated, with an average of three tax years foregiveness each.

 

Hawaii’s Ignored Tax

The use tax is one of the least understood taxes even though everyone who purchases goods outside of Hawaii – through mail-order or online, for example – may be subject to this tax. Because sellers in Hawaii pay GET on their gross incomes, they are at a price disadvantage with out-of-state businesses that don’t pay the tax. Therefore, the use tax equalizes the tax on transactions by requiring those purchasing goods from out-of-state sellers to pay a 4 percent tax, or half of 1 percent for wholesalers.

“Technically, you’re even required by law to pay a use tax on things you buy on amazon.com,” Hironaka says. “But if you buy two DVDs a month, are you going to file a use-tax return and pay 4 percent of $25? All Internet sales are subject to a use tax, but nobody does it.”

Hironaka says the use tax is geared more toward people and businesses that make large purchases, such as machinery or manufacturing equipment, from out-of-state sellers. But even he admits hardly anybody files a use-tax return and, unless it’s a big-ticket item, the state will probably never know about it or investigate the case.

Hawaii Business magazine invites you to comment on our articles and the issues they raise. Comments are moderated for offensive language, commercial messages and off-topic posts and may be deleted. Some comments may be chosen for inclusion in the magazine on the Feedback page.

Old to new | New to old
Jun 13, 2011 03:49 pm
 Posted by  sky8081

It would be interesting to see if the rate of per capita tax evasion cases in Hawaii differs from the rest of the country. This problem is not unique to Hawaii. Though, I wouldn't be surprised in the least if Hawaii had a relatively higher rate of tax evasion given that Hawaii also has one of the highest tax burdens in the country.

Sep 21, 2011 12:26 am
 Posted by  balboa777

I would like to see how much income our Hawaii politicians and their cronies are hiding from the tax laws before any investigation of hard working people that are just trying to survive happens.
Maybe the government should not waste the tax revenue before they start pointing blame on the general public.

Nov 8, 2011 07:20 pm
 Posted by  K american

I want to turn in some bum for his reckless tax evasion but cannot find a phone # to do so this bum evades Hawaii, California, Florida, and all Federal taxes I need contact information !

May 6, 2012 10:16 am
 Posted by  kgwbuss9

I have been working in a work share situation on the Big Island for the last 9 months. The property I work on is a non profit as well as I have a lease agreement which helps me get food stamps. No money is ever exchanged. Countless repairs on rental properties are made for no cost. Taxation is being evaded here big time and regularly.

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