Practice Lets Firms Evade Taxes : Cash Payments on Rise in Construction

A 25-year-old carpenter paused from his work at an Irvine housing tract to explain how he has extra money to spend on new clothes and sprees to Las Vegas that Uncle Sam knows nothing about.

Whenever he can, he said, he works for cash that’s not reported for tax purposes. Last year, he boasted, he earned $11,000 that was tax free.

Such illegal “green money” payments in the construction industry are believed by many government and industry officials to have grown more commonplace in recent years.

They say the growth is in response to keen competition among contractors seeking to lower their costs and aided by the deunionization of construction, increasing resentment of the tax system and a massive influx of undocumented workers from Mexico.

Such under-the-table payments are eagerly sought by a large portion of the work force, who appreciate more money in their pockets. And they are being offered by contractors who find that they can underbid the competition on construction jobs by 20% or more if they can discount their wages by the tax rate and avoid government-mandated employers’ contributions toward state and federal unemployment funds, the disability program and Social Security.

But the scofflaw contractors are spurring a backlash from unions and other contractors who protest that the cheats pose a source of “unfair competition” to law-abiding businessmen.

And in recent months, state regulatory agencies have begun to mount a crackdown of the so-called “underground” economy in the construction industry.

While state agencies acknowledge that it would be unfeasible to catch all violators in the construction industry, they are trying to make their presence felt by working with local district attorneys to file criminal charges against tax-evading contractors they discover.

Last Thursday, for example, the Orange County district attorney--on behalf of the state Employment Development Department--filed felony and misdemeanor charges against three officers of an Anaheim plastering company for failing to withhold deductions for state income tax from cash payments to employees and for failure to make employers’ payments to the state disability and unemployment insurance funds.

The state has a hefty financial stake in deterring tax-cheating contractors. The state’s Commission on California State Government Organization and Economy (known as the Little Hoover Commission) last August reported that an “underground economy” of persons in otherwise legal enterprises who fail to make payroll deductions accounts for “up to $40 billion” in annual transactions in California and represents a $2-billion-a-year loss in state income taxes alone.

“It is a monumental problem,” said C. Robert Simpson, deputy director of the state Department of Industrial Relations. “We estimate that 20% of California’s economy is conducted in the underground.” He added that “a very large portion” of the scofflaws are in the construction industry, which by its very nature is mobile and thus difficult to police.

The Little Hoover Commission made a list of recommendations to curb the tax abuses, including a much better coordinated and more highly publicized enforcement effort among the state’s fragmented tax-policing agencies.

Many union officials and contractors complain that the Internal Revenue Service and state agencies have been slow to follow up leads they receive about cash-paying contractors. They also complain that until now the state’s efforts to curb the underground economy have been hamstrung by a shortage of manpower, especially payroll auditors.

Enforcement agencies retort that finding and proving cases of cash payments among contractors can be very difficult. The most convincing witnesses--the workers who have received cash income without paying any taxes--are fearful of being punished themselves or called to pay the piper. State agencies say that while they do not prosecute workers who act as informants, they cannot exempt them from prior tax obligations.

And very often, state investigators say, an employer’s records of cash transactions are falsified or nonexistent.

‘Contractor Isn’t Stupid’

“The average contractor who gets into this game isn’t stupid,” said John Maloney, registrar of the Contractors State License Board. He said, for instance, that contractors frequently supply part of their workers’ wages by payroll checks with deductions. The rest is paid in cash or additional checks without deductions. If authorities inquire, the contractors show them the books that record the legitimate payments.

And some union contractors have been known to report just enough work hours with deductions to make their employees eligible for union medical and pension benefits, and then split with their employees the savings gained by providing the rest of their wages in under-the-table cash.

As another ruse, those contractors who fail to withhold income taxes, contribute to unemployment and disability insurance or carry workers compensation policies often tell authorities that their workers are not their employees at all but are acting as independent contractors.

When put to the test, these workers would not meet the criteria of being independent contractors--such as control over how and when a job is performed--state officials say. But Simpson, of the Department of Industrial Relations, said it would require “a multitude of lawsuits” to prove that each so-called independent contractor is actually an employee because “each has to be proven or disproven on the basis of fact.”

Checks Are Laundered

To avoid any bank records of large cash withdrawals to make payroll, state investigators and union officials say they have discovered that contractors will launder checks through materials and equipment suppliers.

Bob Scott, a business representative with the Sequoia District Council of Carpenters in Fresno, said he discovered an instance of a dry-wall contractor funneling cash out of his wife’s dog kennel business. In another case, he said, a contractor was giving his workers two checks, one for wages and another for a fictitious purchase of materials.

Scott said he has also heard of instances when contractors have “augmented” the wages of workers with drugs--yet another form of untaxed income.

The loudest outcry against contractors who evade taxes, state officials say, comes from legitimate contractors who complain that they are put at a competitive disadvantage.

Jim Thomas, owner of Castle Construction Inc. in Santa Ana, claims he has “definitely lost some jobs” to competitors who do not make tax deductions and blames the law breaking by contractors on the developers who hire them. “Developers are so cheap they don’t want to pay enough money to get a job done at a fair price,” he said.

Can Bid 20% Lower

Tax accountants estimate that contractors who provide their workers cash or checks without deductions can win jobs by bidding at least 20% lower than contractors who abide by the law. If, as often happens, a tax-evading contractor also does not provide the worker compensation insurance that is required by law, his bidding advantage can be even greater.

“Some contractors, in trying to cut their bid down to the minimum, actually figure into their bid how much cash they can pay,” said Mike Russell, executive director of Associated Builders and Contractors, a trade group. “I think cash payments have to be stopped because it is bad for the industry. It creates unfair competition.”

The current free-for-all competition in the construction industry has been attributed in part to the decline of the unions. Union-affiliated contractors, who are subject to union trust-fund audits, are less likely to evade payroll taxes than their nonunion counterparts, according to Roger Miller, Southern California regional manager for the Department of Industrial Relations.

The greatest prevalence of tax evasion, both contractors and workers agree, is in residential and smaller commercial construction jobs where the unions are the weakest.

Labor leaders, moreover, contend that tax-evading contractors are threatening the survival of union-affiliated contractors who, in addition to paying taxes, must provide their workers with medical and other fringe benefits specified in their labor contracts.

Greed Is Blamed

Blame for an underground economy in construction is placed on the greed of developers, contractors and workers alike.

“We have guys who quit good union jobs we get them and go to work for cash,” complained James R. Swinell, business representative for the Carpenters Local Union No. 2361, which consists mostly of dry wallers.

One carpenter, who belongs to the union, acknowledged that after he accumulates enough payroll hours to qualify for union benefits and to allay the suspicions of taxing agencies, he likes to work for pay without deductions. “I work nine months payroll and three months cash if I can,” he said. “I can make $1,000 to $1,500 a week--all cash.” He said he has no qualms that the government will catch him or someone will turn him in because “it is green money. They can’t prove who I worked for.”

Sometimes a construction worker who collects cash, and thereby has no records of income, also draws unemployment insurance or welfare. “For a while he has two streams of income coming in, both tax free. He has beat the system twice,” Simpson said.

Among the most plentiful sources of labor willing to accept cash in the construction industry are undocumented Mexican workers. They stand in the hundreds at pickup points around Southern California on weekday mornings, waiting for contractors and other prospective employers to offer them low-paying day jobs.

Will Take Home More

At sunup each day, job-hungry Mexican men stand in knots of three or four along a mile-and-a-half stretch of Chapman Avenue in Orange.

“Anything on this street is cash pretty much,” Rubentino, who asked that his full name not be used, said of the kind of work that he and the other men can expect to get there.

Rubentino, 35, said he prefers being paid cash to a payroll check because it means he will take home $40 a day instead of $32 after deductions. Also, he said that since he has no bank account it costs him 5% to 7% to get a check cashed at a cash-checking service.

“I think the reason for the underground economy is in a large part because of the illegal labor,” said John Rutledge, chairman of Claremont Economics Institute, a private investment advisory firm.

The tremendous supply of labor from Mexico is creating all sorts of off-the-books businesses, Rutledge said. He predicted that “the cash economy and the illegal work force will get a lot bigger in the next year to two years” as falling oil prices lead to a worsening of poverty in Mexico and an increasing exodus of young Mexican workers to Southern California.

Lowers Housing Prices

Rutledge said that although the cash underground in construction creates “inequity,” it benefits the economy by tending to lower the price of housing. “First the death of the unions and then (the growth of) cheap labor will enable a lot of people to afford houses who couldn’t afford houses before,” he said.

“Illegal activities could result in greater economic growth for the country and lower costs to the consumer for housing,” agreed John Doti, dean of Chapman College’s school of business and management, although he added that he “would in no way encourage illegal practices.”

Not everyone agrees on how to combat cash payments. Rutledge, a conservative economist, says that “the only cure for it is to make people not have incentive to cheat” by lowering the tax rates.

But many contractors and union leaders are clamoring for more vigorous law enforcement. Since the Little Hoover Commission report last August, the state has revived a dormant program called Interagency Construction Enforcement group, which was established in the late 1970s to encourage cooperation among state agencies that enforce construction industry laws.

Last fall the IRS and the state Franchise Tax Board joined ICE, which also includes the state Department of Industrial Relations, the state Employment Development Department and the Contractors State License Board.

File Criminal Charges

Edwin Sullivan, a deputy director of EDD’s employment tax branch, said the latest approach ICE is taking against the underground economy is for the member agencies to jointly file criminal complaints against contractors, thus bringing to bear all the statutes that have been violated.

Sullivan said criminal prosecution--rather than the simple imposition of civil fines--”has the opportunity to bring with it the publicity that will show to people who are tempted to resort to this sort of thing (cash payments) that it is dangerous, that they are going to get caught.”

As a next step, legislation has been proposed to form a “strike force” composed of representatives of ICE agencies and the State Board of Equalization. The strike force would be assigned its own auditors and investigators and would “focus its efforts on the blatant violations of tax evaders and cash pay transactions,” said Richard Mahan, executive director of the Little Hoover Commission.

Some state agencies say they already are giving higher priority to policing the underground economy. The division of labor standard enforcement of the Department of Industrial Relations has reorganized and for the first time has a field investigation staff specifically assigned to the construction industry. In 1985, the division issued 141 citations to contractors for cash-payment violations and fined them $342,200. A contractor can be fined $100 per employee for each pay period he fails to make payroll deductions.

In an attempt to give state enforcers a helping hand, the Southern California District Council of Laborers is urging passage of new state legislation that would require each contractor to file a public report with his bank setting forth the wages and taxes he pays on construction jobs. The bill, AB 4150, sponsored by Assemblyman Alister McAlister (D-Santa Clara), chairman of the Assembly Finance and Insurance Committee, would give third parties, such as labor unions, the ability to search for payroll discrepancies and file civil actions against offending contractors.