In a concerted crackdown on California's thriving underground economy, state and federal agencies are launching an investigation of payroll fraud in the state's construction industry, authorities said Friday.
Spurred by reports of tax evasion and lack of employee safeguards in the construction business, the California Employment Development Department and the Internal Revenue Service have focused on dry wall contractors as their first target. Framing and roofing contractors, they say, will be next.
The investigation of dry wall businesses will begin July 1 and will center initially on five high-growth counties in Southern California: Orange, San Diego, Imperial, San Bernardino and Riverside. Eventually, the crackdown is expected to expand throughout the state.
Industry experts estimate that as many as 1,450 licensed dry wall contractors operate in Southern California. Dry wall contractors install wallboard materials as new homes and commercial structures are built. They generally work as subcontractors to larger developers.
Limited Orange County investigations in 1987 and 1988 led officials to believe that many dry wall contractors are paying workers in cash to avoid required withholding of federal and state income taxes, Social Security, unemployment insurance, disability insurance and workers compensation insurance.
Robert L. Balgenorth, executive secretary of the Building & Construction Trades Council of Orange County, contends that the dry wall industry is one of the worst offenders in the construction business.
"This industry is in incredibly bad shape with regard to the law," Balgenorth said Friday. "It's on the verge of everyone saying, 'Why should we pay taxes at all?' "
Cash payments are against the law and rob state and federal governments of income taxes due on earnings, said Loren Ferguson, an administrator with the EDD's tax enforcement section. In addition, workers are left without protection if they are hurt on the job or laid off.
"In the construction industry, there's a lot of room to be less than legal," Ferguson said. "Cash payment to workers is one of the biggest problems."
It is also the basis of a huge underground economy, experts say. In 1985, the Commission on California State Government Organization and Economy estimated that underground economic activity accounted for up to $40 billion in business transactions annually and defrauded the state of more than $2 billion each year in taxes.
Although such criminal activities as drugs, prostitution and gambling are included in the figures, the commission's report said the "largest segment of the underground economy . . . involves self-employed persons and employers and employees who pay or receive cash for work performed or for goods sold without withholding proper income, payroll or sales taxes."
The crackdown was announced Friday at a Newport Beach seminar to educate dry wall subcontractors about their state and federal tax responsibilities.
Ferguson said that, beginning in about two weeks, auditors from the EDD will cull lists of licensed dry wall contractors and verify that they are registered with the EDD and paying payroll taxes. Those who are not registered--along with a random sample of those who are--will be investigated.
To date, the state's 400 EDD auditors police all industries and have no special emphasis, Ferguson said. In the upcoming crackdown, up to 30 auditors will focus solely on the dry wall industry.
All contractors who are found to be violating the law by paying their workers in cash will have civil or criminal charges brought against them, Ferguson said.
The minimum civil penalty is a fine equal to 25% of the unpaid taxes, he said. Those dry wall contractors found to have "willfully" broken the law could face jail time and fines of up to $20,000 per count.
"If we find what is a real willful case of non-compliance, we will press criminal charges," Ferguson said.
Paying workers in cash gives contractors an unfair competitive advantage when bidding for work against those who uphold the law. Because these employers do not register with the EDD, they are able to avoid paying a variety of taxes and can give lower bids than their law-abiding counterparts. And jobs typically go to the lowest bidder.
"It's a widespread concern not necessarily limited to the dry wall industry," said Donald Kearin, executive administrator of the California Drywall-Lathing Industry Labor-Management Cooperation Committee. "It's across the construction industry, in some trades more than others."
At the Friday seminar in Newport Beach, Tony Croteau told the 50 assembled government officials and dry wall contractors about one of his company's latest defeats in bidding against a dry wall company that pays in cash.
"I got beat by 35% in my bid on a 600-house tract being built by an international development company," said Croteau, who owns CWC Inc. in Ventura County. "My men said they know the company that beat us pays cash. I went to the development company, and you know what they said? 'So what.' "