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Competing with the Underground with Help from Uncle

How can any sign professional or business hope to survive against competition that isn't burdened by licensing requirements or fees, insurance costs or even taxes?

By Mark E. Battersby

How can any sign professional or business hope to survive against competition that isn't burdened by licensing requirements or fees, insurance costs or even taxes?

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  • Several years ago one study reported that Greece, where all the troubles are today, had a shadow economy that was a whopping 30 percent of its GDP. In this country, the Government Accountability Office (GAO), Congress's watchdog agency, estimates the income tax "gap," the difference between taxes owed and taxes actually paid, is in the hundreds of billions of dollars.

    Admittedly, many businesses benefit from the low wages demanded by workers from the underground economy and the economy as a whole may also benefit from the reduced prices charged for goods and services by individuals and businesses working in the shadows. But, how can any legitimate sign business hope to compete?

    Competing with shadows
    The businesses and individuals participating in the so-called "underground economy" usually want to avoid government regulations and may not be licensed in their trades. The underground business capitalizes on the "tax wedge," the difference between labor costs paid by an employer (gross wages) and the net wage received by an employee. An employer will pay wages of $50 per hour, which includes payments to FICA, FUTA, Medicare, retirement benefits, workers compensation insurance, etc., but the employee will net a wage of only $30 per hour. In the underground economy the same worker will charge $30 per hour, cash, for the same work and the net result will be the same.

    With the help of Uncle
    The not-always-so-silent partner of most sign businesses, the Internal Revenue Service, is all-too-well aware of the underground economy and has published a guide for its auditors to find and collect taxes from individuals and businesses operating in the shadows.

    Although the tax rules currently require every business to report annual payments in excess of $600 made to an individual in order to be tax deductible and soon all expense deductions to be supported by filing the Form 1099 information return, workers in the underground economy take extreme care to make sure income cannot be reported on Forms 1099.

    A key trait of the underground worker or business is that they will try to always get payments in cash. If that is impossible, they will provide a false social security number. The undergrounder knows that social security numbers cannot be immediately verified and will not accept any further work from that payor. Another tactic the undergrounder may use is to explain that he or she is the sole shareholder in a corporation with the same name, i.e. John Smith Plumbing (just make it out to John Smith.)

    The IRS has long known the best way to locate members of this shadow economy is through cash invoices found in examinations of businesses that have made payments to these individuals and businesses. When the IRS examiner encounters payments for goods or services made in cash and verified by questionable, possibly handwritten, invoices, it is very likely the taxpayer paid a so-called "undergrounder" to do the work.

    The IRS usually asks further questions to determine how the taxpayer located the underground worker, and if the worker is known to work for other local businesses, or if they worked on personal jobs for the taxpayer. There are a number of other methods used by the IRS to find those operating in the underground economy.

    Locating, locating, locating
    Underground economy workers can be found on community bulletin boards. Theirs will be the handwritten 3x5 cards, or the business cards that do not list a license number when needed. Because they will not advertise in the typical ways, the undergrounder will make flyers to leave on doors and will rely on contacts made at donut shops and local restaurants. Remember, the underground entrepreneur will frequent local spots and rely on local contacts. They will be known to legitimate businesses that will send work their way when a job is too small or labor intensive for the legitimate business.

    The IRS has discovered the most lucrative time to locate workers from the underground economy is when they use their cash to make significant purchases. The nature of the business is that large amounts of cash are accumulated, but must be used very carefully. Vacations can be taken if expenses can be paid in cash.

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    Gambling is a good diversion for the cash earner and illegal activities, like drug purchases, always accept cash. But, eventually the undergrounder will want to enjoy the earnings or invest them, and this is the time the IRS identifies them. Here are a few other ways:

    • Real estate (usually vacant land) will be purchased from private parties, so any large cash transactions remain hidden, but the title transfer will be recorded.
    • Barter activity. In the underground economy goods and services are easily traded between individuals. When the undergrounder acquires assets (a used tractor, work truck, computer) or services (house gets painted, car seats reupholstered) this is income earned in the underground economy.
    • Loan applications. If any loans were applied for, the undergrounder may identify his or her source of income. Thus, loan applications are fertile ground for IRS examiners. Even prior year information is helpful and can lead the examiner to discover the source and use of hidden income.
    • Civil, criminal and Family Court records reveal if any lawsuits were filed against the individual. Creditors or wronged business associates will list known assets or pledged collateral in court filings. Divorces can disclose hidden income or assets.
    • Third Party Contacts-Possible business associates, former spouses, and creditors are all frequently contacted for information.

    The underground online
    Cash plays an essential role in every community, and the reality is that the nature of cash, because it is easy to use anonymously, means there will always be an opportunity for tax evasion by people dealing in cash. Fortunately, the use of cash and cash-like items is not as undetectable as its users believe.

    The IRS is well aware digital cash (also known as e-money, electronic cash, or digital currency) is just like real cash, except it's not tangible. It's money, or a money substitute, such as script, that is exchanged only electronically. Electronic Funds Transfer (EFT), direct deposit, PayPal and WebMoney are all examples of electronic money. These digital currencies offer irrevocable online payments, easy online access, and most importantly: identity protection.

    Some banks have partnered with cell phone companies to offer banking services. An account is opened at a bank and a deposit is made. An ATM card is issued. The user can now transfer the funds on deposit to any cell phone user. For example, a business can transfer funds to a partnered supplier, who receives the funds electronically into their cell phone account and ships the merchandise.

    Blowing the whistle
    Obviously, many of the strategies available to IRS auditors for finding and taxing individuals and businesses in the underground economy are not feasible for those operating a legitimate sign business. Often partnering with the IRS is the only way to compete against those in the underground economy.

    The IRS Whistleblower Office pays money to people who blow the whistle on those who fail to pay the tax that they owe. In fact, the IRS is legally obligated to pay awards to people providing specific and credible information if that information results in the collection of taxes, penalties, interest or other amounts from the noncompliant taxpayer. Remember, however, the IRS is looking for solid information, not an "educated guess" or unsupported speculation.

    Because they are also looking for a significant Federal tax issue -- this is not a program for resolving personal problems or disputes about a business relationship -- the law provides for two types of awards. If the taxes, penalties, interest and other amounts in dispute exceed $2 million, and a few other qualifications are met, the IRS will pay 15 percent to 30 percent of the amount collected.

    The IRS also has an award program for other whistleblowers -- generally those who do not meet the dollar thresholds of $2 million in dispute or cases involving individual taxpayers with gross income of less that $200,000. The awards through this program are less, with a maximum award of 15 percent up to $10 million. In addition, the awards are discretionary and the informant cannot dispute the outcome of the claim in Tax Court.

    The IRS has developed and published a number of Audit Technique Guides (ATGs), the latest of which reveals how much they know about "cash intensive businesses," and the underground economy. While the strategies employed by the IRS's auditors won't work for a sign professional, the ATG should be a warning about just how much the IRS knows and a reminder that payments made to the underground worker must be reported via a Form 1099 if the sign business hopes to claim a deduction for the outlay.

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