State auditing pulling millions from downtown bars

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February 5, 2013
By: Nick Halter
Envy nightclub allegedly underpaid its sales taxes by $50,000 to $60,000
Nick Halter
Nick Halter
Revenue goes to pay for a new Vikings stadium

At first glance the revenue numbers look unbelievable: Downtown Minneapolis patrons are spending 40 percent more now than they were just two years ago.

A recently released Minneapolis financial report showed that over the past two years, downtown alcohol sales revenues have jumped by 25 percent and 16.7 percent each year, adding an additional $1.3 million to the city’s coffers in just 18 months.

On the surface, the strong alcohol tax revenues are great news for city leaders, because that money goes toward paying for a new Vikings stadium. Once the stadium is paid off the city will be able to spend sales tax revenue as it sees fit, perhaps on a Target Center renovation, upgrades to the Convention Center or other economic development projects.

But numbers provided by the Minnesota Department of Revenue show that much of the gains in downtown nightlife revenues are the result of better state auditing of bars across Minnesota.

State audits turned up $2.6 million in underpaid taxes at downtown establishments in 2012, compared to just $261,000 in 2010, a 1000 percent increase.

The increase in tax auditing revenue coincides with the creation of a new Department of Revenue enforcement unit that is meant to go after businesses that do most of their transactions in cash, more specifically bars.

The special enforcement unit was created in July of 2010, and since then audits at downtown bars have discovered millions in underpaid taxes downtown, compared with just a few hundred thousand in the two years previous.

The Department of Revenue, however, said it’s too early to say if the increased auditing revenue is the result of the new enforcement unit or just coincidence.

“That’s really kind of too short of a time period to detect a trend. It could be a bump rather than an ongoing trend upward. A couple more years and we’ll be able to tell,” said Ellen Auger, the assistant director of the department’s sales and use tax division.

In December, city of Minneapolis Chief Financial Officer Kevin Carpenter could not explain why alcohol tax revenue grew by 40 percent in two years.

But after hearing the audit numbers, he agreed that increased enforcement is likely to blame for the booming alcohol tax revenues.

“It would be a very reasonable and appropriate explanation for why (the alcohol tax) is so dramatically bigger year over year,” Carpenter said. “I appreciate your calling it out, because it’s going to be something that is going to factor into our longer-term thinking.”

The city will depend on four revenue sources over the next 30 years to pay for a Vikings stadium: The aforementioned downtown alcohol tax, plus a tax on hotel rooms, downtown food sales and a citywide sales tax of a half-percent.

Alcohol taxes only account for about 9 percent of the roughly $52 million the city receives annually for the Vikings stadium and Convention Center. Most of the money — $30 million in 2011 — comes from the citywide sales tax. 

That’s why Carpenter isn’t worried about the inflated alcohol tax numbers. The other taxes revenues are also increasing. Third quarter numbers show a 3.2 percent jump in sales tax revenue, a 3.7 percent jump in food tax revenue and a 2.8 percent increase in lodging tax revenue.

The city is depending on at least a 2 percent increase to tax revenue each year to pay for the stadium. Carpenter said that if you take out big gains to the alcohol tax, the city is still well above its 2 percent estimate.

Carpenter also said that the citywide sales tax numbers — which account for over half of revenue for the Vikings stadiums — are shaping up nicely for the end-of-the-year city financial report.

“It wouldn’t surprise me at the end of the year if we saw a 5 percent growth in sales tax,” Carpenter said.

Are downtown bars skimming?

If state tax auditors are finding millions in unpaid taxes from downtown Minneapolis bars, does that mean that these establishments have been cheating the state for years?

That may be a question that doesn’t have an answer, because state law protects audit information from the public. The public cannot find out which businesses are getting audited.

In fact, the public can’t even figure out how the Department of Revenue determines which businesses to audit.

“We can’t disclose how we select audits. That’s protected by (state law),” said David Delaney, who supervises the new special enforcement unit.

In the Department of Revenue’s description of the special enforcement unit, it lists bar auditing as the No. 1 project.

Auditors, according to the description, are looking for underreported sales by comparing liquor revenue with liquor orders. They’re looking for bars who collect a cover charge but don’t report that revenue to the state. Auditors also look for liquor sales that are reported as food sales to avoid a larger tax.

“Through our audit selection process, we like to focus on those businesses that are furthest from compliant,” Delaney said.

In 2012, the Department of Revenue audited just six bars and discovered $2.6 million in underpaid taxes. In 2010, it audited nine bars, but turned up only $261,000. Those numbers mean that the average audit in 2012 found $437,000, compared to just $29,000 in 2010.

A source who declined to be named with knowledge of the downtown bar industry said some of the audit revenue likely came from cover charges. The source said some bar owners will get behind on their rent and pay off their landlord via a cut of their cover charge revenue, avoiding having to report the cover charges.

The only recent public example of the Department of Revenue’s auditing comes from Envy nightclub in September. Police executed a search warrant for unpaid income taxes by the owner, but the warrant also alleged that the club was skimming cash from the registers and grossly underreporting revenue.

The warrant estimated that the club owed $50,000 to $60,000 in underpaid sales taxes from food, alcohol and cover charges. 

Delaney said the unit doesn’t target Minneapolis.

“Today, I have some auditors in St. Paul, so our focus is not any geographic unit,” Delaney said.

By the numbers 

— $51.9 million: Amount of money the city of Minneapolis received from alcohol, lodging, food and sales tax in 2011. The money will be used for a new Vikings stadium as well as other projects.

— $4.6 million: Amount of money the city receives from alcohol taxes downtown, about 9 percent of the $51.9 million.

— 3 percent: The additional sales tax added onto an alcoholic beverage purchased in downtown Minneapolis.