The number of known methods to evade fuel taxes and defraud government is substantial. Those listed here are the more common schemes plaguing tax collection efforts though frankly, the following is hardly an exhaustive detailing of the entire landscape of fuel tax evasion.
Cross-Border Evasion (Bootlegging) Across State Lines
Bootlegging is a fuel tax evasion method in which fuel is purchased in a state with a low tax rate then delivered to a state with a higher rate. This method of FTE is so simple to commit, yet so complex to decipher, that a separate article has been provided in this issue for a more comprehensive analysis (see article, “The Ghost of FTE”).
Bootlegging from other countries runs a similar path of fraud as cross border (bootlegging) evasion with Canada and Mexico being the primary assumed import countries utilized for this type of evasion. Bills of lading are typically forged or altered to hide the tax evasion.
Abuses Due to Presence of Native American Reservations
According to the Battelle study mentioned in other articles in this issue , “The issues faced by tax agents and compliance officers due to the presence of the Native American exemption are significant.” There are some 562 tribal nations in the United States spread across the country from Florida to California.
The problem for fuel tax collection on reservations is that they are technically sovereign nations within the borders of the United States which makes them difficult to monitor and police. Reservation gas stations can easily import low-tax fuel and export it to communities outside of the reservation without paying appropriate taxes. Further, reservations can receive tax credits or refunds for fuel sales to enrolled tribal members which leads to false reporting and abuse of such credits.
Jacking the Discount
“Jacking the Discount” is the common term for rebate fraud. Corporate gas station chain’s largest accounts are trucking companies. By agreeing to fill their trucks at a chain’s stations, the trucking company is offered rebates, or discounts. In a discount jacking scheme, when rebate payments come due, retailers short the trucking company what they are owed according to the contract. This form of fraud is easy to perpetrate on smaller trucking companies whom often do their own calculations as to what they are owed through manual inputs in a spreadsheet, or worse, a paper log book.
In 2015, one case was revealed to have defrauded roughly 2,400 trucking companies of close to $66 million dollars.
According to a report by Kendrick Oil, one discount jacking scheme which ran for five years was easy to conduct, according to the perpetrator, who “reportedly told the FBI that it was easy to perpetrate as many buyers were not tracking their purchases closely enough.” The sales rep also indicated that in a warped sense they felt “justified in taking advantage of people who did not know any better.”
According to Desert Fuels, “Expensive fuel orders which can exceed $30,000 a load coupled with sketchy pricing transparency due to frequent pricing fluctuations and the fact that most sellers and buyers are still using ‘archaic ordering and tracking systems’ provides an easy target for fraud.” From the Desert Fuels report, in an interview with the FBI, one perpetrator was quoted: “Some of ‘em don’t know what a spreadsheet is. I’m not kiddin’…If the guy’s sophisticated and he truly has gone out and gotten deals from the other competitors and he’s gettin’ daily prices from us, don’t jack with his discounts, ‘cause he’s gonna know, okay?”
Fraud of this type is not endemic of independently owned gas stations. In the most notorious case of discount jacking, the Billionaire owner of Pilot/Flying J, Jimmy Haslam, cut a deal in 2014 to resolve his company’s admitted guilt in a multi-million dollar diesel rebate fraud. Haslam’s company paid nearly $150 million in fines and restitution as a result of an FBI investigation and raid on Pilot’s headquarters in 2013. Haslam, who also owns the NFL’s Cleveland Browns, still faces potential prison time for the fraud. This scheme did not just cheat trucking companies out of dollars owed, but also in discounts owed to the Feds. One of Pilot’s largest customers is the Federal government in fueling cars and trucks for the U.S. Postal Service and other agencies.
Under Reporting and Non-Filing
Under-reporting and non-filing schemes are endemic in states were the point of taxation is “below the rack.” (See Map/chart on page 22 “State Level Point of Taxation). In states where the terminal rack is the point of taxation, it is difficult to under-report or not file unless the terminal operator is cooperating with the fraud, which is rare. However, some thirty states do not tax at the terminal.
In a non-filing scheme, tax-free fuel is bought then sold as tax-paid fuel to either middle men distributors or retailers. Taxes are evaded by simply “failing” to file the appropriate tax forms to declare the product as being taxable. In other cases, forged registrations by distributors which allow them to buy non-taxable fuel (where their current registration may only allow the purchase of taxed fuel) falls into this category.
Underreporting is a simple method of fuel tax evasion to understand. Again, this is typical in states where distributors/wholesalers and retailers are responsible for paying tax on gallons sold. This method of FTE (along with non-filing) seems pervasive in the industry especially when retail gas station owners also control companies which supply their gas stations. Acting as their own distributor, they can more easily obfuscate total fuel sales. According to the Chicago Tribune, “more than one-fourth of Illinois gas station operators underreported the amount of fuel they [sold] to the public” during a four year period from 2007 to 2011. It took four years to detect the fraud as investigators poured over thousands of paper documents comparing the amount of gasoline delivered to the amount reportedly being sold. In March 2017, a New Jersey businessman who owned four gas stations in Illinois “was sentenced to 1 year, 9 months in prison for under-reporting his business sales by $41 million” according NJ.com.
False Product Labeling
As some fuels serve more than one purpose, in some instances these products are taxed and in others they are not. Additionally, some products that are not taxed can also be used for applications where fuels should be taxed. Kerosene, used fuel, aviation fuel, and dyed diesel are all examples of non-taxed items which can be blended with diesel or repurposed for use in diesel applications. Off-road use dyed diesel is the clearest example of a non-taxed product that can be used as a “taxed” product by simple mis-labelling of the product as being taxed diesel.
False Refunds or Credits
In this type of FTE, a buyer or seller claims tax refunds or credits on fuel sold for one purpose (tax free) yet used for another (taxed). The more exemptions and credits offered by a state, the higher the potential for this type of fraud. According the Battelle study, “tax systems with a point of taxation high in the distribution chain (e.g., the terminal rack) tend to generate higher rates of refund and credit filings as taxpayers recover payments made on taxed fuel used for nontaxable purposes.” By claiming that sold fuel is being used in agricultural equipment, off-road vehicles, government applications, or any other number of non-tax uses, the perpetrator can claim any number of refunds or credits.
Failure to Remit Tax Payments
In states where taxes are not paid at the terminal upon purchase and removal from the terminal rack, distributors/wholesalers are responsible for paying the tax. By not filing IRS returns indicating fuel sales, the tax is not collected. Though this type of evasion is eventually detected through long periods of non-filing by a company, if a company has been formed with an alias, the perpetrators can be difficult to find. This type of fraud can also be perpetrated by companies who actually use the fuel in their own vehicles such as trucking carriers in filing claims on fuel expenses in their corporate returns.
Cocktailing is a simple fraudulent activity to understand. There are a variety of non-taxed fuels that can blended with taxed fuels to increase total volume. Diesel is especially prone to this type of fraud as kerosene, aviation fuel, bio-diesel, waste oil, and even alcohol can be added to diesel without obvious detection. It is assumed that this type of fraud is widespread as detecting blended fuels requires chemical testing of each load suspected, or outright observation of the activity. Cocktailing is also estimated to be the cause of countless millions in damage to engines as blending methods are often a guess-work game.
The classic daisy chain scheme was made famous by organized crime in New York during the 1980’s. In its first five months of operation, A.K.A. Petroleum Sales Corporation bought and sold eight million gallons of gasoline earning it $10 million in profits. The problem, as should have been suspected in its name (AKA, “also known as”), is that the company “had no office, no delivery trucks, no storage tanks, no employees and no customers” according to a New York Times article from 1989. In a Daisy Chain, several “dummy company” distributors are set up to “launder” fuel, as it were, selling fuel bought at a terminal to one another. The fuel is eventually sold to a legitimate retailer. As fuel is “passed” from one distributor to the next, the distributing company responsible for the tax then fails to pay the tax. This company is called the “burn company” as when investigators finally determine that it has not paid such taxes, the company essentially disappears.
New York officials estimated that up to $1 billion in Federal revenues was stolen in New York City and its suburbs in 1988 alone from these scams. One billion dollars, in 2017 dollars, is $2.59 billion in losses. For one state… when tax rates were much lower. States that have moved their point of taxation to the terminal level have avoided this problem. New York, and most other states, still tax and the distribution level.
Dyed fuel abuses
Dyed-diesel has a red dye added to it to distinguish it from regular diesel fuel. Dyed diesel is tax exempt as it is to be used exclusively for off road purposes such as off-road vehicles recreational vehicles, farm tractors, heavy construction equipment, and generators. This tax break is intended to help industry and agriculture, but it also makes it a key target for exploitation for tax evasion. Dyed fuel abuse can occur at any level of the distribution chain.
Dyed Fuel fraud can take place through removing dye from diesel (through bleaching, masking (adding other dyes to dilute the red color), adding sulfuric acid, filtration, and re-refinement), failing to add dye to diesel, tampering with fuel dye equipment, or outright sale of dyed fuel for the purpose of using it for taxable reasons.