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Michigan Zaps Zappers – Cash Business Owners Beware!

August 8, 2012

The State of Michigan recently enacted tax enforcement legislation making it illegal to sell, purchase, install, transfer or possess automated sales suppression devices, aka “zappers.” The new legislation takes effect on August 28, 2012 and violators face a one-year minimum mandatory jail sentence and severe financial penalties.

Zappers are used to illegally underreport cash receipts, a practice that can occur at point-of-sale businesses such as restaurants and retailers selling small dollar amount items. For example, a business may gross $250,000 per month and underreport (skim) receipts by $50,000. A zapper software “entrepreneur” can visit the store and, after corroborating with the owner or manager, quickly and accurately modify the sales records a) by transaction b) by day c) to the penny, resulting in the credit card charges and cash deposits equaling what is reported on the books. Another scenario is for the peddler to sell a USB drive to the store owner or manager and provide technical support. In essence, zapper software creates a second – electronic – set of books.

Zappers’ Electronic Fingerprints

Those selling zappers to business owners or managers tout that it leaves no electronic fingerprints, and thus is invisible to the IRS and other law enforcement agencies. The reality is that zappers leave telltale electronic fingerprints, and the IRS and other agencies have sophisticated techies who can readily check a computer system and flag evidence of a zapper.

Those who raid businesses with search warrants typically take away computers, hard drives, USB thumb drives, and other hardware for inspection by highly sophisticated technicians. In a well-publicized Michigan zapper case, the owner of a chain of thirteen suburban Detroit restaurants  and his wife were found by the IRS with zapper software that underreported over $16 million in skimmed revenues.  The owner was indicted on tax and other charges, is currently a fugitive living in Lebanon, his wife went to jail, and the government seized and sold the formerly prosperous restaurants.

Absentee Owners: Audit for Zapper Use

Business owners may also become victims of zapper scams if managers or key employees use zappers to hide embezzlement This is especially likely for absentee owners and entities with multiple locations. In addition to being the victim of the skim, the larcenous employee may tell the IRS and Michigan Treasury that the owner was behind it. Such owners may protect themselves by unannounced electronic audits to determine if any zappers have been used.  A telltale sign is that servers, per managers, need to be replaced with unusual frequency.  That can well be  an attempt to hide evidence of electronic tampering.

Michigan Zapper Penalties Include Mandatory Jail, Fines

The zapper legislation has teeth.  In addition to a one-year minimum mandatory jail term, there is a fine of up to $100,000.  However, from a monetary perspective, there is another more costly provision which requires disgorgement of “all profits associated with the sale or use of a zapper.  In the above example, if the skim is $50,000 a month, then $600,000 a year is subject to forfeiture.  The offending party is also responsible for all Michigan sales, withholding and other taxes, penalties and interest.  These other levies include the corporate income tax and  individual income tax.  Typically cash businesses that use zappers also pay employees all or some of their wages in cash “under the table” and/or purchase food or inventory for cash.

The recent Michigan legislation is patterned after another enforcement problem the Michigan Department of Treasury encountered and overcame: false cigarette tax stamps. The Michigan Treasury was hemorrhaging cash because of cigarettes that were brought in from out of state and counterfeit Michigan stamps were purchased on a flourishing underground market. The Department of Treasury urged the legislature to adopt legislation in which the mere possession of cigarettes with counterfeit stamps required a minimum prison term. The mandatory jail time virtually ended the fake stamp problem overnight and Treasury receipts from cigarette taxes swelled.

IRS Also Targeting Zappers

Zapper programs originated in Europe and migrated first to Quebec in North America.  They came from jurisdictions where there were value added taxes.  The IRS has taken certain steps to target businesses that might employ zappers, and the State of Michigan has taken notice.  It should be pointed out that Michigan’s vigorous criminal and civil penalty regime is separate and distinct from the IRS, which is also free to pursue the same individual and business.  There is an exchange of information agreement between the IRS and the Michigan Department of Treasury.

Zappers represent significant lost sales tax and other tax dollars to states. For example, three years ago, California estimated zappers at restaurants cost that state $2.8 billion annually in receipts. New York estimated $1.7 billion in annual lost receipts. In an era of record state fiscal problems, this is real money.

How have the IRS and Michigan uncovered businesses running zappers?  A secret ceases to be secret when two or more people know about it.  Additionally,  anyone who has knowledge of the scheme and who may have reason to talk to authorities (such as a problem with the DEA, IRS, FBI or other law enforcement agency) may readily give up the business owner in exchange for no prosecution or a reduction in charges or sentencing.  For example, a metro Detroit freelance IT salesman peddling zappers to bars and restaurants was discovered when a party with law enforcement issues named him.  That salesman, in exchange for an extremely lenient sentence,  identified and cooperated with federal law enforcement in prosecuting numerous customers for tax evasion.  Some of his customers went to jail. The IRS and other federal and state agencies are seasoned veterans of how to play that game most effectively.

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