Something fishy was going on at a popular Bellevue restaurant, and it wasn’t related to the seafood specials.

During a routine audit, Washington Department of Revenue officials noticed that Facing East Restaurant was reporting a suspiciously low volume of cash sales. Seven percent of customers were paying for their meals with cash, according to Facing East, compared to the industry average of 22 to 30 percent for dine-in restaurants.

State auditors found something else suspect: At night, the amount of cash taken out of the register to pay the servers’ tips often exceeded the restaurant’s daily cash sales. The state’s subsequent investigation led to the first conviction for “tax zapping” in Washington in 2016.

Officials say tax zapping costs Washington state millions of dollars annually in lost revenue. It occurs when retailers use software to delete cash sales from the register’s running total—hiding a portion of their sales from the state Department of Revenue and pocketing part of the sales tax owed to the state.

“This is a way that businesses evade paying taxes, and it’s obviously illegal,” says Jon Lee, a doctoral student at Washington State University’s Carson College of Business and a fellow at the college’s Hoops Institute of Taxation and Research Policy.

Lee is researching ways Washington can combat tax zapping through strategies that encourage businesses to stay on the correct side of the law. The research, which is part of his doctoral dissertation, grew out of cooperative efforts between the Hoops Tax Institute and the state.

The institute was established in 2012 by the late Howard (’50 Hosp. Mgmt.) and Billie Hoops to increase public awareness of tax issues. During the years Howard Hoops worked for the American Red Cross, the couple traveled extensively, and Hoops noticed that few people understood taxes or their role in government.

“Part of his vision was to create a place where students would work on solutions to real-world tax issues,” says Jeff Gramlich, accounting professor and director of the Hoops Tax Institute.

When Gramlich heard about tax zapping, he figured it would be a rich area for academic study. Mike Chertude, who manages the Department of Revenue’s Computer-Assisted Audit Program, agreed.

One national expert estimates that tax zapping could be costing Washington more than $400 million annually. While no one knows the extent of the problem, tax zapping siphons away revenue the state depends on to pay for essential services like public safety and parks, Chertude says.

 

TAX-ZAPPING SOFTWARE is believed to have originated in Europe, where residents pay a hefty 20 percent value-added tax on many goods.

Chertude was dubious when he first heard about tax zapping—it sounded too brazen to be real. But a series of high-profile cases in Canada during the 1990s revealed how pervasive use of the software is. The phrase “tax zapping” came from a confiscated floppy disc, which had the word “zapper” written on it.

In the case of the Bellevue restaurant, the owner showed state employees how she plugged a USB drive into her point-of-sales system at the end of each month. When she ran the software, a pop-up window asked her to select how much in cash sales to delete from the daily transaction record.

Yu-Ling Wong, Facing East’s owner, pled guilty to first-degree theft and unlawful use of sales suppression software. She was ordered to pay $300,000 in restitution and to comply with five years of court-order monitoring.

Thirty-three states have laws specifically prohibiting the use of tax zapping features, which can also be built directly into point-of-sale systems or used in cloud-based sales reporting. In Washington, possession of the software itself is illegal. But tax zapping remains difficult to detect and prosecute.

“You don’t automatically know if something is missing,” Chertude says.

In some cases, Department of Revenue employees ate at restaurants that were being investigated, paid for their meals with cash, and later checked to see if their purchase showed up in the cash register’s tally.

Although several high-profile prosecutions have involved restaurants, Chertude says tax zapping extends beyond the hospitality industry. He suspects the practice is prevalent in other retail industries and also in the sales of personal services, some of which are subject to Washington’s sales tax.

 

AT THE HOOPS TAX INSTITUTE, Lee researches “behavioral nudges” that help keep businesses in compliance with the law.

In an earlier survey conducted by Lee and a WSU faculty member, people were asked to assume the role of a sole proprietor for a lawn care company where many customers paid in cash. About a quarter of the survey respondents were self-employed.

Half of the respondents reported their sales to the government in a lump sum. The other half broke out cash sales from credit and debit card sales.

Survey respondents who listed cash sales separately from electronic sales reported higher income—and thus paid higher
taxes—than the other group.

The study demonstrates that “simple steps like reporting cash sales separately” could encourage business owners to report their full income to the state, Lee says.

As part of his research, Lee also is evaluating the effectiveness of campaigns to alert business owners to the penalties for tax zapping and offer amnesty programs to companies that self-report violations. “It’s the carrot and stick approach,” Lee says. Without an amnesty program, offenders might not be willing to come forward.

Chertude is eager to see the results of Lee’s research. Given the time it takes to investigate a case of suspected tax zapping, he’s interested in knowing what else might work.

“It could be as simple as encouraging customers to keep their sales receipts and providing an incentive for them to send those sales receipts to the state,” Chertude says. “If the business owner knew there was a copy of that transaction, they might be less likely to stray.”

 

Learn more about the Hoops Institute of Taxation and Research Policy.