Honor system: no fault in skipping sales tax, but bill still due.

CHAD Kassis likes to cut his friends a break.

When they come into his Cahuenga Boulevard pizza parlor, he makes them pay for their meals, but sometimes he'll skip the sales tax.

"It's like, 'OK, I'm taking care of the guy,'" admits Kassis, 25, owner of Milano Pizzeria.

And it's not just the small tabs that get that 8.5 percent discount. To garner business from the nearby film studios, he'll offer the same discount on $300 delivery bills.

Actually, there's nothing illegal about skipping sales taxes for a meal or on a roll of film at a convenience store--just so long as the business itself pays the taxes owed, which Kassis insists he does.

But not everyone is so honest.

Across Los Angeles and statewide are thousands of duly licensed businesses that seem a world apart from the street vendors who overtly reside within the underground economy. Yet many of these businesses straddle both worlds, avoiding sales taxes where they can, ignoring business taxes entirely, and cutting other corners, such as buying supplies on the Internet in order to bypass the sales tax.

"I'm sure it's out there, but the question is how big is it?" said Chris Thornberg, an economist with the UCLA Anderson Forecast, who has studied the region's informal economy.

Sales tax avoidance

The top problem involving smaller businesses is avoidance of the sales tax, either through not paying all that is owed, out of ignorance or error, or through an intent to deceive.

The state Board of Equalization, the state agency responsible for collecting sales taxes, conducts up to 20,000 audits a year on roughly 1 million businesses registered to sell taxable products. Those audits generated about $340 million in delinquent sales and use taxes in the 2001-2002 fiscal year, the last period for which comprehensive data is available. (A use tax involves items purchased from out of state.)

The audits are conducted on businesses that the board believes are likely to be underpaying their taxes. "The ways are only limited by the imagination of the retailers," said Vic Anderson, who oversees the board's civil audit program.

Businesses will also intentionally report sales that are far lower than they should be, given the average markup, while some small businesses will make payments with virtually no records to back them up.

Another common tax avoidance device auditors uncover: owners treating their small businesses like their personal candy stores, taking home items purchased wholesale by the company for personal use.

"'I am having a party tonight and want to take home a 12-pack,'" Anderson said. "If I owned a grocery store, why would I want to go anywhere else and pay retail? But they owe taxes on it."

Sometimes, business owners just get confused--or at least feign confusion--on which items are taxable: services such as a haircut are not and tangible items such as pens are. Food can be tricky--it's generally not taxable except for a host of exceptions.

Jeff Green, who owns a Wilshire Boulevard convenience store with his parents, says he tries to follow the sales tax laws as best he can, but he notes that the food regulations can be hard to follow. "I just go by a rule of thumb. If it's food-to-go it's not taxable, but any of my gift baskets I tax," says Green. "I think I'm careful."

And when he wants to cut a customer a break, he doesn't forgive the sales tax, saying it interferes with his bookkeeping system. Instead, he'll just lower the price on an item, as he did one day last week when a customer wanted to buy eight batteries and he dropped the price 25 cents, to $1 a pop.

The penalty for simple negligence is 10 percent; another 25 percent can be slapped on in addition if auditors believe there is intent to deceive. Then, there's 8 percent annual interest.

The board also brings felony criminal charges against a few dozen businesses each year when the amount owed totals more than $25,000 in a one-year period and the board believes it can show an intent to defraud.

A mid-Wilshire auto mechanic was audited twice in the past 10 years, the last time resulting in his paying a civil fine and interest. He said that the audit was a nightmare, requiring him to produce all sorts of paperwork to defend his tax payments. Since then, he claims he has been scrupulous about payments, including installing new computer software that he says makes it easier to keep accurate and complete records.

"You've got to keep your paperwork," says the mechanic, who asked his identity not be revealed. "You can't cheat."

But Richard Lowenstein. a Los Angeles County deputy district attorney who has worked on several criminal sales tax avoidance cases, says he has not seen a computer register system that can't be circumvented.

"There are all kinds of ways, and even if they are honest there are so many mistakes going on," said Lowenstein, noting a common method is simply failing to ring up sales with owners pocketing the cash.

Then there are more sophisticated schemes.

Last month, Lowenstein, working with board agents, brought a sales tax avoidance case and six felony charges against Ramil Abalkhad, president of RJ Financial Inc., which operates a chain of mall jewelry stores.

Abalkhad is accused of failing to pay more than $390,000 in sales taxes during a three year period ended in 2001 by claiming he sold merchandise to wholesalers when in fact he sold it to retail customers.

He has been accused of going so far as to forge receipts, a scheme that was uncovered when board agents contacted the wholesale buyers that were listed and who denied they had bought merchandise from him. "I suspect you have the crime of non-reporting pretty much happening all the time, but (the board) has limited resources and really can't check everything," Lowenstein said.

Ablakhad and his attorney could not be reached for comment.

New challenges

If that weren't enough, the board is combating a growing problem of tax avoidance through Internet sales. The board collected more than $100 million in its 2001-2002 audits from businesses that did not pay such taxes.

Dina Hay, who administrates the board's Southern California criminal investigation division, said some small businesses will purchase cigarettes from out-of-state suppliers, saving the 47 percent state excise tax on tobacco and 8 1/4 percent sales tax, allowing them to retail them at a huge discount.

"We have that on a smaller scale with some retailers," she said.

Then there is the widespread avoidance of Los Angeles' business tax, which is more complicated than many smaller cities that may simply assess an annual fee based on the number of employees.

The Los Angeles tax requires businesses to pay from about one tenth of one percent to six-tenths of one percent on their gross annual receipts. And while the city collects about $360 million annually, there are estimates that perhaps as much as $60 million goes uncollected, much of it by businesses that bother to pay nothing.

Rex Olliff, a finance specialist with the city's Chief Administrative Office, says that many businesses may be betting that given the relatively small amounts of money at stake, at least compared to the sales tax, they won't be caught.

And they are not necessarily wrong, he said, given the cost of conducting an audit. "There are limitations in what we can do," he said.

The city is considering simplifying the tax to encourage more compliance.