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Friday, April 6, 2012

Tax gap, tax-cheating software tools and what to do

Zappers are a device that allows some sales to just not get reported. They are also known as “automated sales suppression devices." An article in August 2011 in Governing magazine noted the reality that business owners could remove millions of dollars of sales and income from their records ("In An Uphill Battle, States Fight Tax 'Zappers'" by Holeywell).(Also see this August 2008 New York Times article.)

To help combat them, BloombergBusienssweek reports that five states have enacted legislation outlawing them ("State governments target tax-cheating software" by Adams, 4/3/12). The states: Florida, Georgia, Maine, Utah and West Virginia. This article also notes:

"Boston University tax law professor Richard Ainsworth, an authority on the issue, estimates that 30 percent of the predominantly cash businesses in the states are using tax zappers."

Of course, it is not only the states losing money - so is the federal government. I wonder if any of this is factored into the recent tax gap estimates from the IRS of a $450 billion annual tax gap.

Legislation outlawing the sale or use of these devices sounds like a good first step, but the problem is that people already willing to break the law are unlikely to be deterred by another law they might also find is easy to skirt. The devices can also likely be purchased from outside of the U.S. And there are alternatives such as the old-fashioned approach of just not reporting cash sales.

Additional solutions? There have been proposals in the past to require small businesses to use a single bank account for their revenues and deductible expenses so that reporting from the bank can help the IRS and state tax agencies know what happened. See for example, page 261 of this 2011 GAO report. This isn't perfect, but should help.

What do you think?


Dana said...

I find the blog entry on zappers very interesting - it appears that the scam used on the past by small business owners of keeping two cash registers yet reporting the sales from only one register has evolved. Modern technology (the zapper with sophisticated software) now allows one to alter or delete sales receipts for cash transactions and cheat the system by underpaying taxes. I started reading more about the topic and seems like the issue is starting to receive more and more attention from restaurant trade organizations and tax authorities. These organizations now recognize the problem may be more prevalent that initially thought. A Google search for "cash register zapper" returned a whopping number of links (over 89K), including sites that seem to sell or advertise the device and the software - this shows that the information about these devices is out there, accessible to the individual inclined to commit tax fraud. I was also surprised to see how intuitive the software used with the zappers is. Richard T. Ainsworth in "Zappers: Technology‐assisted Tax" illustrates how the manipulation happens and how the "edited" sales records look like. Easy to use but not easy to detect by the untrained eye.

With billions of dollars of lost tax revenue annually due to the tax gap, finding a practical solution is what is now needed. But where should we start? I am fully convinced that a practical and sustainable solution does exist - modern technology created the problem but can also help solve it. Maybe we start with understanding the pros and cons of best practices of countries that tried a solution, like Greece or Germany. Ryan Holeywell in "In An Uphill Battle, States Fight Tax 'Zappers'" notes that in Greece, all cash registers must be certified as tamper-proof before being sold. He further notes that in Germany, a tamper-proof device that records sales data is welded into registers. Auditors can access that data when they arrive onsite. Other solutions may exist - on-site certifications by authorized third parties; remote verification of POS using smart software; encryption of the software used by electronic cash registers/POS. But it all needs to start with increasing awareness of the problem and discussing the problem and potential solutions in the appropriate forums.

Article: “Zappers: technology-assisted tax fraud, SSUTA, and the encryption solutions.(Streamlined Sales and Use Tax Agreement)”; Author: Ainsworth, Richard Thompson ; Date: June 22, 2008; Website:

Article: “In An Uphill Battle, States Fight Tax 'Zappers”; Author: Ryan Holeywell; Date: August 25, 2011; Website:

Jiung Jeong said...

Zappers, tax-cheating software tools, are predominant among cash businesses such as restaurants as those tax-cheating tools underreport many taxable sales from the businesses to the government at the end of year. Many taxpayers who use zappers would normally record sales without manipulation during business hours, but they use zappers to recalculate the total receipts after business hours, creating totally different taxes owed. As a result, employers of the businesses would have extra cash in their pockets. Assuming that those employers pay their employees in cash, the employees who get paid in cash would report themselves as qualifiers for welfare programs, putting more burdens on state budgets.

It is normally known that tax expenditures that create complexity to taxpayers as to whether particular tax codes fit into their situations lead to the tax gap. However, human errors that occurred from the tax expenditures and intentional activities that occurred from illegal tools should be differentiated, because intentionally activities mean tax fraud. Additionally, tax evasion by illegal means, as opposed to a legal way of reducing taxes owed by applying tax rules, should be handled seriously by the government, as those intentional and illegal ways would create a wider tax gap and economic inefficiencies.

Although more than 30 percent of cash businesses use tax zappers to manipulate taxes owed, it would take so much time to catch them by auditors as they would visit each business one by one to see whether tax zappers are in use. Therefore, it is more important to give warnings and bring awareness to taxpayers to lessen tax gap and help grow economy of the nation.