Tax Crime and Punishment in the Chinese Restaurant Business

 

One of the first articles I ever wrote for Menuism was entitled "Why Do Some Chinese Restaurants Change Their Names So Often".  In that article, one of the reasons cited why Chinese restaurants seemingly changed their names for no reason at all was a sales tax dodging scheme.  In this scam, after not reporting all of your sales, you then dissolve the corporation operating the restaurant, then open up a similar or identical restaurant at the same location, but in a new corporation and operating under a new restaurant name.   Practically speaking, this reduces the period of time that the government has to catch up with you for sales tax evasion.    Who knows how many Chinese restaurants stiffed the local authorities of how much sales tax over the years? 

No documented cases of this scheme exist, either because the restaurants got away with it, or there was no publicity involved if they were apprehended.  However a longtime Chinatown CPA assured me years ago that this was a longstanding practice among some Chinese restaurant operators.  And my list of the 8200+ Chinese restaurants I have eaten at contains a number of suspicious changes in the English name of the Chinese restaurant, often accompanied by the retention of the Chinese language restaurant name.

However, there have been some other very high profile cases of Chinese restaurant tax evasion in recent years for which there is a public record that we can discuss here.  The poster child for well publicized tax avoidance schemes of restaurants was the Sam Woo chain in the Los Angeles area.  Sam Woo's episode is the most specific information that has ever gone public regarding this kind of activity, and given the magnitude of the punishment here, including jail time of between 3 to 9 years, we can imagine the Sam Woo situation was egregious.   Many Sam Woo branches were sold off to pay the avoided taxes, and the fact that a few branches were not sold off reflects that those branches had different ownership and were not involved in the tax scheme.

It does appear that Sam Woo took advantage of the above mentioned sales tax avoidance strategy once, back around 2010, when the Sam Woo in Los Angeles Chinatown closed down and was replaced by something called Hong Kong BBQ.  Now they did print new menus, so while the look and feel of the restaurant was the same, I couldn't be sure if maybe somebody came in and bought the business and decided run it in a similar manner, but a waiter assured me it was the same operation.     Now given that the criminal action against Sam Woo noted above only went as far back as 2012, it does appear that they got away with something with their Hong Kong BBQ maneuver. 

It is interesting that California made such a big deal of the Sam Woo prosecution, in so doing shining a bright light at what had only been hinted at. The sins of Sam Woo were detailed in a news release from the State of California as follows.

Sales tax underreporting.    For over thirty years, the Sam Woo branch in Los Angeles Chinatown was one of the busiest restaurants in Chinatown.  It was also probably the biggest one that operated on a cash only basis, which was a pain when dining there.  But now we know why this, and some other branches of Sam Woo in the Los Angeles area operated on a cash only basis.  

Income tax underreporting.  Obviously income tax underreporting can go hand in hand with sales tax underreporting when running a cash only business.   However as discussed below there can be some surprising twists and turns as to this element.

Payroll tax underreporting.  This was was suggested by a cryptic comment made by the same waiter noted above who attributed the change in identity of the original Sam Woo as being forced by the government for being in business for so long.  And indeed payroll tax fraud was one of the counts against Sam Woo, not only by underreporting employee wages, but perhaps more importantly, misstating the rate of employee turnover, which lowers your unemployment tax rate.  (For you tax geeks out there, this means claiming the lower new employer unemployment experience rate than using your higher actual historical rate.)

Last on the list was worker compensation fraud tied to underreporting reported wages.  I suspect this was done for the payroll figures reported for worker compensation purposes to be consistent with payroll tax reporting, and might not have been intended to be a separate source of fraudulent gain, but which did serve to reduce the worker compensation insurance premium.

Subsequently the Mama Lu Dumpling chain in the San Gabriel Valley also hit the headlines with their own tax evasion troubles, caught red handed for avoiding over $2 million in taxes, primarily California sales taxes.  By repaying the avoided taxes, the owners were able to reduce their jail sentences.  You can read the government press release here.  (Again, as with the Sam Woo episode, not all Mama Lu branches were involved in the scheme due to different ownership.)   And previously there had been whispers a few years back that the breakup of a well known mini chain of Hong Kong cafe style restaurants, located mostly in the San Gabriel Valley, where most of the locations changed hands, was necessitated by being caught by the long arm of the tax authorities for sales tax evasion.

Most recently, earlier this year several Los Angeles area Chinese buffets repaid over $10 million combined in evaded California taxes, and their owners were handed jail sentences of up to nearly three years, for evading the same types of taxes in the Sam Woo prosecution.  Among the Chinese buffets prosecuted were well known San Gabriel Valley restaurants Gold Hibachi Buffet and Kami Buffet.  Once again, California publicized the matter with a detailed press release. Similar actions have been reported with Northern California Chinese buffets.

Mention should also be made of  the unofficial "Mayor of Chicago Chinatown" Tony Hu, who owned a string of Chinatown restaurants including Lao Sze Chuan, named by numerous publications as the best Chinese restaurant in the United States, and was sent to prison for a year and fined $100,000 on vague tax evasion and money laundering charges.  However this was small peanuts compared to the California prosecutions.

 

Which brings us to this interesting poster I found at an unnamed Chinese restaurant in Rowland Heights, California.

 

Item 2 in the hiring sign highlights probably the most prevalent tax related secret in the Chinese restaurant community, that some Chinese restaurants pay their employees partly in cash.  Not that everybody doesn't know about the practices of restaurants not reporting cash sales, and paying employees at least partially in cash.  However, there are some interesting twists to this arrangement.  In the case of the Mama Lu Dumpling House tax evasion episode, note the vast majority of evaded taxes were sales taxes, while only a small portion were income taxes.  But shouldn't the greater amount of taxes evaded be the unreported income taxes?   

The answer lies in the fact that the benefit of cash payment of wages goes primarily to the worker, not the employer.   Most people assume that to the extent a restaurant owner has cash sales that they pocket unreported the entire amount that they receive.  But as I first learned as a boy accountant 50 years ago, that is nowhere near the case.  Not reporting $1,000 in cash sales doesn't mean that $1,000 in reporting of income on the income tax return has been avoided.   Rather if some of that cash is used to pay out expenses of operation, such as employee wages, then those expenditures would not be deductible for income tax purposes, and the restaurant has avoided the income tax only on the net cash retained, if any.

But the biggest surprise of all is that in some cases, restaurant owners are forced into this cash wage situation, and are not pleased about it, as I learned when one of them complained to me about the system.  That is because a lot of Chinese restaurant workers demand at least partial payment in cash, which enables them to minimize the income they report to the government, qualifying them for various social services available to low income individuals.  (Having known a Chinese restaurant manager who drove a Mercedes and was on Medicaid, I can attest that this really happens.)  This is becoming even more of a dilemma for restaurant owners, because to make this system work, the restaurant has to have cash sales.  And as our society becomes more and more cashless, particularly as influenced by the pandemic, there are fewer cash receipts available to make cash payments to employees.

If there's a takeaway in the help wanted poster that includes lack of cash wage payments as a core job requirement, it may well be that paying Chinese restaurant workers in cash has been a more common practice than any of us were aware of, but also one which may be going away as Chinese restaurants make more and more cashless sales.

 Xishang Roodle in Santa Ana won't take your cash