Calling it the largest sales suppression software case in state history, Washington State Attorney General Bob Ferguson announced the filing of criminal charges last week against the owner of six restaurants for allegedly using illicit point-of-sale software to delete cash transactions and pocket more than $5.6 million in sales tax. The charges include six counts of first-degree theft and three counts of possessing and using sales suppression software, commonly known as a “zapper,” which is illegal in the state of Washington. This case is yet another example of aggressive action undertaken recently by state authorities against zappers, and should serve as a stern warning to business owners making use of such technology.

Sales Suppression Software

Commonly called “zappers,” sales suppression software programs run on a point-of-sale computer or cash register and are used to secretly delete some or all of a restaurant’s cash transactions and then reconcile the books of the business. The result is that the company’s books appear to be complete and accurate, but are in fact false because they reflect fewer sales than were actually made. Business owners using zapper programs often maintain two sets of books, in order track the business’ real revenue. A recent article published by BNA estimates that tax-zapping software costs states $21 billion in taxes annually and that 30 percent of the electronic cash registers, or point-of-sale systems, in the United States have a zapper installed.

State of Washington v. Salvador Sahagun

According to the charging documents (available here, here, here, and here), the defendant, Salvador Sahagun, operated six restaurants in West Seattle, Broadway, Greenlake, Fremont, Lynnwood, and Marysville. During an audit, an auditor with the Washington State Department of Revenue found that point-of-sale records from these restaurants did not match with tax returns submitted by Sahagun. The auditor also found that the majority of sales receipts were missing from Sahagun’s point-of-sale system.

The press release announcing the charges notes that Department of Revenue employees, suspecting that Sahagun was using sales suppression software, visited the seven restaurants on several occasions and paid cash for their meals. The auditor then compared the employees’ receipts with the receipts on the point-of-sale system to determine whether the transactions existed and the amounts matched. The auditor found that three of the restaurants were using sales suppression software to delete or underreport cash transactions. The auditor determined that the other three locations also owed sales tax. The amount of taxes owed from each of the six locations ranged from $43,339 to $2,197,460. In total, the auditor determined that the owner owed $5,615,497 to the state.

State of Washington v. Yu-Ling Wong

While the case filed against Sahagun may be the largest in Washington state history, it is not the first. In February 2016, Washington’s Attorney General filed what he called the “first-of-its-kind” criminal case against a Bellevue restauranteur, Yu-Ling Wong, for using sales suppression software to avoid paying nearly $400,000 in state sales tax. That case began as a routine audit by the Washington State Department of Revenue, which trains its auditors to detect the use of revenue suppression software. Auditors noted an unusual change in cash receipts, as compared to the restaurant’s historical cash receipts, determined that the restaurant’s point-of-sale system could not be trusted, and eventually uncovered the use of Zapper software, which had been provided by a software salesman named John Yin. Yin worked for a Canadian company called Profitek, which sold point-of-sale systems for the hospitality and retail industries. The audit was thereafter referred for criminal prosecution, and the Washington Attorney General executed a search warrant at Yin’s residence. During a law enforcement interview conducted during execution of that search warrant, Yin admitted he sold the Zapper software in approximately 2007 and trained Wong in how to use it.

In August 2016, Wong pleaded guilty to first-degree theft and unlawful use of sales suppression software. The court ordered Wong to pay $300,000 in restitution to the Washington Department of Revenue. In addition, Wong’s business entered a corporate guilty plea to first-degree theft, unlawful use of sales suppression software, and filing a false or fraudulent tax return. In an unusual provision, both Wong and the business are subject to monitoring by the Department of Revenue for a period of five years.

United States v. John Yin

As a result of Washington’s investigation and prosecution of Yu-Ling Wong, the Justice Department announced federal criminal charges against John Yin in December 2016. According to the publicly-filed charging document and guilty plea agreement, Yin worked as a salesman for Profitek from at least 2009 through mid-2015. In addition to its Canadian headquarters, Profitek has offices in China and a growing dealership network across North America. Profitek designed, marketed, sold, and supported revenue suppression software (RSS) – commonly referred to as a “zapper” – as an “add-on” to its Profitek point-of-sale software. The RSS functioned only with the Profitek POS software.

Yin acknowledged in his guilty plea agreement that he successfully sold the POS software, and assisted in the widespread distribution of the Zapper add-on, to dozens of customers in and around Seattle over the course of several years. The Zapper software could only be ordered from a supplier in China, so Yin would put his clients in touch with the Chinese company and facilitate their purchase of the software. Yin also serviced the Zapper software once his clients purchased and installed it.

Yin further admitted that his clients’ use of Zapper software allowed them to consistently and significantly underpay their various federal, state, and local taxes, including business and occupation taxes, Social Security and Medicare taxes, and federal income taxes. The plea agreement stated that eight restaurants in the Seattle area were audited by the Washington State Department of Revenue and found to be using Yin’s Zapper software. The total amount of state sales and federal income taxes avoided by these establishments during the period 2010 through 2013 was $3,445,589.00.

Yin entered a guilty plea on December 2, 2016, to wire fraud and conspiracy to defraud the U.S. government. Yin agreed to make full restitution, in the amount of $3,445,589, to the IRS and Washington state. He was eventually sentenced to 18 months in prison.

Other States’ Efforts to Combat Zappers

Many states in addition to Washington have passed laws outlawing the use of revenue suppression software, including Michigan, Illinois, Connecticut, Florida, Georgia, Utah, and West Virginia, and others — like Mississippi — are considering proposals to enact such laws. The Washington state law, passed in 2013, makes it a class C felony for anyone to “sell, purchase, install, transfer, manufacture, create, design, update, repair, use, possess, or otherwise make available” software or hardware that deletes transactions.

While Washington state appears to be taking the lead in prosecuting business owners who use zappers, it is not alone in that effort. In December, Michigan Attorney General Bill Schuette announced that a sushi restaurant outside Detroit has been ordered to pay nearly $1 million in restitution and to serve a five-year sentence of probation for embezzling sales tax paid by customers and underreporting its income. The restaurant, Sushi Samurai Inc., entered a guilty plea and its owners, Dong and Christina Chang, also pleaded guilty to filing false monthly sales tax returns and filing false joint income tax returns.

In August 2017, the Illinois Attorney General announced that a Chicago restaurant owner was charged with underreporting sales by $1 million. The charges alleged that the defendant used a zapper to falsify electronic sales records in order to avoid paying the full amount of sales and use taxes owed each month. This case was the first zapper prosecution in Illinois, which banned sales suppression software and devices in 2013.

In July 2017, Connecticut’s Department of Revenue Services arrested and charged a New Haven restauranteur with various offenses for using sales tax suppression software. According to a press release announcing the charges, this was the first time the State of Connecticut has charged an individual for using “zapper” software.

Paging the Internal Revenue Service

Conspicuously absent from recent coverage of state efforts to detect, and prosecute, businesses and individuals who employ sales suppression technology is the Internal Revenue Service. Businesses that use zappers to avoid paying sales taxes are presumably underreporting their receipts for federal income tax purposes as well, thereby providing the IRS with an opportunity to at least audit income tax returns if not investigate potential federal tax crimes. Other than the federal prosecution of zapper salesman John Yin, however, the federal government does not appear to be playing a significant role (at least publicly) in the ever-widening crackdown on zappers by state lawmakers and prosecutors. In a few of the state cases, IRS agents appear to be playing no more than a supporting role to state investigators. While we expected a wave of federal prosecutions to follow the Yin case, so far that has not happened. One can only wonder whether the IRS will join the anti-zapper bandwagon or allow the states to continue to lead this fight.

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The U.S. Supreme Court has scheduled oral arguments for April 17 in South Dakota v. Wayfair, a case that could dramatically reshape the sales tax landscape for online retailers.  As previously reported, under current Supreme Court precedent in Quill Corp. v. North Dakota, a state may compel a business to collect its sales taxes only if the business is physically present in the states.  South Dakota v. Wayfair directly challenges Quill – which was decided in 1992, before internet sales became what they are today.  States strongly object to the Quill standard because it cuts into their tax revenue, since they cannot impose sales tax collection obligations on out-of-state online retailers who sell to in-state customers.

South Dakota filed its brief on the merits on February 26; Wayfair Inc. must file its brief by March 28.  We continue to monitor developments in South Dakota v. Wayfair and provide further updates.

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The Pennsylvania Department of Revenue this week will start mailing “non-participation penalty assessments” to delinquent taxpayers who failed to participate in the 2017 Tax Amnesty program, Revenue Secretary Dan Hassell announced yesterday. “Individuals and businesses that failed to take advantage of the program will be assessed a 5 percent penalty on their unpaid amnesty eligible delinquencies, as the law requires,” Hassell said. “The department is taking the appropriate steps to ensure that delinquent taxpayers are aware of their outstanding liabilities and the additional penalties they now face.”

Act 84 of 2016 authorized the Tax Amnesty program to net an estimated $100 million for the 2016-17 fiscal year budget. The program exceeded that estimate by providing $130.4 million in net revenue to the Commonwealth of Pennsylvania. The program ran for 60 days, between April 21 and June 19, and allowed eligible individuals and businesses to pay past-due state taxes while having all the penalties and half of the interest waived. Act 84 required the Department of Revenue to notify all known delinquent taxpayers in writing of the existence of the Tax Amnesty program. As a result, the department mailed notification letters to approximately 800,000 known delinquent taxpayers. The statute also called on the department to publicize the program to maximize public awareness and participation.

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