CROSSING THE LINE : WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION John M. Polson, Esq.

1. CROSSING THE LINE: WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION John M. Polson, Esq. jpolson@laborlawyers.com Sheldon J. Blumling, Esq. sblumling@laborlawyers.com Atlanta • Charlotte• Chicago • Columbia • Fort Lauderdale • Irvine • Las Vegas • New Orleans • Oakland • Orlando • Portland • San Diego

2. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION • What is SUTA Dumping? • General Information • SUTA Dumping and the PEO Industry • Mechanics • Federal Legislative and Regulatory Activity • SUTA Dumping Prevention Act of 2004 • DOL’s Model State SUTA Dumping Act Language • How to Avoid SUTA Dumping • Questions

3. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION What is SUTA Dumping?

4. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION

5. What is SUTA Dumping?General Information Definition • Manipulation of a state’s UI tax experience rating system to achieve a lower UI tax rate than that associated with your actual unemployment experience • Typically involves the shifting of payroll among multiple legal entities, particularly in the context of a merger, acquisition or restructuring

6. What is SUTA Dumping?General Information The “Perfect Storm” • Economic slowdown has taken its toll on many state UI systems: • More individuals receiving benefits • Benefit increases and/or extensions • Many state UI systems are on the brink of insolvency: • Significantly higher employer UI taxes • Federal bailouts of state UI systems

7. What is SUTA Dumping?General Information The “Perfect Storm” • Employers are looking for any way to reduce UI tax burden • DOL is pressuring state workforce agencies to step up UI tax enforcement efforts Result: A full scale governmental assault on SUTA Dumping activities

8. What is SUTA Dumping?SUTA Dumping and the PEO Industry Not Unique to the PEO Industry However . . . • Concept appears to have originated in a DOL-funded study on the employee leasing industry’s effect on state UI systems • At least one state workforce agency states informally that it views SUTA Dumping as primarily a PEO industry problem

9. What is SUTA Dumping?SUTA Dumping and the PEO Industry Focus is on PEO Industry • Enforcement efforts seem to be focused on the PEO industry • PEOs are attractive targets because of the large amounts of payroll that they handle

10. What is SUTA Dumping?SUTA Dumping and the PEO Industry Audits and Retroactive Assessments • Many PEOs are being audited, particularly those with multiple wholly-owned legal operating entities • Some are resulting in large retroactive UI tax assessments, based upon a theory that the PEO should have been paying UI taxes on a consolidated basis

11. What is SUTA Dumping?Mechanics Employer UI Taxes are Experience Rated • UI tax rates increase with the number of former employees who receive benefits • In theory, creates incentives for employers • New employers with no experience typically start with a fixed UI tax rate somewhere between the lowest and highest experience-based rates

12. What is SUTA Dumping?Mechanics Origin of Concept • December 31, 2002 DOL advisory letter to all state workforce agencies • SUTA Dumping is “a new term for an old activity that some employers have used to avoid high UI tax rates” • Two general types of SUTA Dumping transactions • Purchased Shell Transactions • Affiliated Shell Transactions

13. What is SUTA Dumping?Mechanics Purchased Shell Transactions • New Company A purchases Existing Business B with a low/minimum UI tax rate • Existing Business B’s low/minimum UI tax rate is transferred to New Company A under state laws dealing with employer succession and transfer of experience • After transfer of low/minimum UI tax rate, New Company A begins operations

14. What is SUTA Dumping?Mechanics Affiliated Shell Transactions • Already established and operating company forms multiple additional companies • Small amounts of wages are reported by additional companies and UI taxes are paid on those wages until each additional company earns a minimum UI tax rate • Major portion of original company’s payroll is moved to one or more additional companies with minimum UI tax rate

15. What is SUTA Dumping?Mechanics Shell Transactions not Exclusive • Example: “Payroll Parking,” where the selling PEO “parks” all or part of its payroll with another PEO that has a lower UI tax rate • Purchased Shell and Affiliated Shell Transactions seem to be the focus

16. What is SUTA Dumping? Result of Full Scale Governmental Assault • Culminated in recent passage of H.R. 3463, the SUTA Dumping Prevention Act of 2004 • Many activities once considered “good tax planning” will be prohibited tax avoidance in the form of SUTA Dumping

17. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION Federal Legislative and Regulatory Activity

18. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 • Signed into law by President Bush on August 9, 2004 • Requires all states to implement laws that prohibit SUTA Dumping as a condition to continue receiving federal funds for the administration of their UI systems

19. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 Effective Date • Generally, the 2006 calendar/rate year • Should see state legislative efforts shortly

20. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 Two General Components • Implement laws aimed at preventing Purchased Shell and Affiliated Shell transactions • Implement laws that impose “meaningful” civil and criminal penalties upon not only those who knowingly engage in SUTA Dumping activities, but also those who knowingly adviseothers to engage in such activities

21. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Prevent SUTA Dumping Transactions • “[I]f an employer transfers its business to another employer, and both employers are (at the time of transfer) under substantially common ownership, management, or control, then the unemployment experience attributable to the transferred business shall also be transferred to (and combined with the unemployment experience attributable to) the employer to whom such business is so transferred.”

22. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Prevent SUTA Dumping Transactions • Purpose is to prevent Affiliated Shell Transactions • With respect to PEOs, would likely require the transfer of unemployment experience if client accounts are transferred from one wholly-owned operating entity to another, even if the transfer of client accounts is made for legitimate business reasons that are unrelated to unemployment taxes (for example, if a PEO reorganizes its business to group similar types of clients in separate wholly-owned operating entities)

23. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Prevent SUTA Dumping Transactions • “[U]nemployment experience shall not, by virtue of the transfer of a business, be transferred to the person acquiring such business if-- (i) such person is not otherwise an employer at the time of such acquisition, and (ii) the State agency finds that such person acquired the business solely or primarily for the purpose of obtaining a lower rate of contribution”

24. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Prevent SUTA Dumping Transactions • Purpose is to prevent Purchased Shell Transactions • Generally, no unique application to PEOs

25. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Impose Penalties “Meaningful” civil and criminal penalties upon: • Those who knowingly engage in SUTA Dumping activities • Those who knowinglyadviseothers to engage in such activities

26. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 State Laws to Impose Penalties “Knowingly” means having actual knowledge of or acting with deliberate ignorance or reckless disregard for the prohibition involved

27. Federal Legislative and Regulatory ActivitySUTA Dumping Prevention Act of 2004 Additional Requirements • Implement laws that require or prohibit the transfer of UI experience in accordance with future DOL regulations • Appears that the federal government will continue to be involved in the states’ UI tax enforcement efforts • Establish procedures to identify the transfer or acquisition of businesses for purposes of SUTA Dumping • DOL’s website provides that an automated “SUTA Dumping Detection System” is being pilot tested this fall and should be distributed to all state workforce agencies in the first quarter of 2005

28. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language • Issued on August 13, 2004 • Suggested legislative language for state laws mandated by the Federal Act • Similar to Federal Act, there are two general components to the language

29. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language Language to Prevent SUTA Dumping Transactions (a) If an employer transfers its trade or business, or a portion thereof, to another employer and, at the time of the transfer, there is substantially common ownership, management or control of the two employers, then the unemployment experience attributable to the transferred trade or business shall be transferred to the employer to whom such business is so transferred. The rates of both employers shall be recalculated and made effective immediately upon the date of the transfer of trade or business.

30. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language Language to Prevent SUTA Dumping Transactions (b) Whenever a person who is not an employer under this Chapter at the time it [sic] acquires the trade or business of an employer, the unemployment experience of the acquired business shall not be transferred to such person if the Commissioner finds that such person acquired the business solely or primarily for the purpose of obtaining a lower rate of contributions. Instead, such person shall be assigned the [applicable] new employer rate under section [insert section of state law].

31. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language Language to Prevent SUTA Dumping Transactions [(b) continued] In determining whether the business was acquired solely or primarily for the purpose of obtaining a lower rate of contributions, the Commissioner shall use objective factors which may include the cost of acquiring the business, whether the person continued the business enterprise of the acquired business, how long such business enterprise was continued, or whether a substantial number of new employees were hired for performance of duties unrelated to the business activity conducted prior to acquisition.

32. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language Language to Impose “Meaningful” Civil Penalties • Employer that knowingly engages in SUTA Dumping activities -- Assignment of the highest unemployment tax rate possible under state law for up to four years, with a minimum increase of two percent • Person who knowingly advises others to engage in SUTA Dumping activities -- A fine of up to $5,000

33. Federal Legislative and Regulatory ActivityDOL’s Model State SUTA Dumping Act Language Language to Impose “Meaningful” Criminal Penalties • Applies to both knowingly engaging in and advising others to engage in SUTA Dumping activities • In either case, the language provides for the imposition of criminal penalties and describes, for example purposes, the crimes of “class A felony” or “Class B misdemeanor”

34. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION How to Avoid SUTA Dumping

35. How to Avoid SUTA Dumping Requires an analysis of: • The requirements of applicable state law • The specific set of facts

36. How to Avoid SUTA Dumping Applicable State Law Requirements • Should become more and more consistent as the states begin complying with the Federal Act, particularly if many states decide to adopt the DOL’s model language • Until then (and likely after, as well), each state’s laws have their own nuances and should be analyzed separately with respect to the same set of facts • Keep in mind that this analysis may change after states begin complying with the Federal Act

37. How to Avoid SUTA Dumping Analysis of the Facts • Consolidating multiple legal operating entities for UI reporting purposes may not be permissible under all circumstances • Unilateral consolidation may itself be considered SUTA Dumping • Unfortunately, there is not one clear solution for every set facts

38. How to Avoid SUTA Dumping At Risk of Being Accused of SUTA Dumping • Paying UI taxes in a particular state through multiple wholly-owned legal operating entities that have different UI tax rates, particularly if the majority of your payroll is under the entity with the lowest UI tax rate • Restructuring your PEO, even for valid business reasons that are unrelated to UI taxes, when the restructuring results in a net lowering of your aggregate UI tax burden

39. How to Avoid SUTA Dumping At Risk of Being Accused of SUTA Dumping • Marketing PEO services as a means to consolidate UI experience • Could be characterized as either knowingly engaging in or advising others to engage in SUTA Dumping activities

40. How to Avoid SUTA Dumping Things to Keep in Mind • Aggressive enforcement efforts • Potentially catastrophic civil penalties • If it saves UI taxes, query whether it may be considered SUTA Dumping • Now is the time to review structure and practices

41. CROSSING THE LINE:WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION Questions

42. CROSSING THE LINE: WHEN UI MANAGEMENT BECOMES SUTA MANIPULATION John M. Polson, Esq. jpolson@laborlawyers.com Sheldon J. Blumling, Esq. sblumling@laborlawyers.com Atlanta • Charlotte• Chicago • Columbia • Fort Lauderdale • Irvine • Las Vegas • New Orleans • Oakland • Orlando • Portland • San Diego