SAN BERNARDINO, Calif.-Two California professional employer organizations must pay $14.6 million to the State Compensation Insurance Fund for allegedly perpetuating a scheme to illegally reduce their workers compensation premiums and payroll taxes, a state court has ruled.

A San Bernardino County superior court in San Bernardino, Calif., late last month awarded the judgment against Ideal Payroll Plus Ltd. and Ideal Management L.P., according to a spokesman for SCIF. San Francisco-based SCIF insured the Rancho Cucamonga, Calif.-based employee leasing companies. The court rendered a default judgment because the Ideal entities did not contest the charges.

SCIF alleges that David W. Clancy Jr., a partner in the Ideal entities, enrolled workers in a "K1 dividend distribution plan." Under that plan, PEO workers received two checks for their work, the insurer said.

One check allegedly paid workers "W-2 wages," and the other one provided a dividend. But the so-called K1 dividends paid to the workers were not reported to SCIF or to state or federal tax authorities, the insurer alleges in its suit against the Ideal companies.

Dividend amounts usually totaled more than half of the employees' wages, SCIF's suit alleges.

"This type of payroll avoidance, using a dividend, we haven't encountered before," the SCIF spokesman said, although he acknowledged that underreporting payroll to obtain inappropriately low workers comp premiums does occur.

SCIF said it uncovered the alleged scheme through an audit and then cancelled its policies and filed a lawsuit seeking damages. The judgment, ordered Dec. 22, includes about $1.3 million in unpaid premium, interest and costs.

Additionally, California's insurance code allows SCIF to collect 10 times the difference between the premium paid and the properly calculated premium when an employer knowingly misrepresents its payroll to lower its workers comp insurance bill, according to SCIF.

"We hope that this judgment will send a strong message and serve as a deterrent against other companies who are considering defrauding California's workers compensation insurance system," Charles Savage, SCIF vp and general counsel, said in a statement.

SCIF said it is still pursuing civil action against individuals involved in the alleged scheme, including Mr. Clancy. California law prohibits SCIF from commenting on possible criminal action, but a spokesman for the California Department of Insurance, which prosecutes fraud, said the agency has been notified of the case. He declined to elaborate.

Mr. Clancy could not be reached for comment, but a spokeswoman for the office of Robert F. Schauer, an attorney representing Mr. Clancy, said that a default judgment was issued because Mr. Clancy's operations are defunct. Furthermore, such a judgment does not prove SCIF's allegations, the spokeswoman said.

Employees of the leasing companies paid taxes, and the businesses' workers comp arrangement was a form of self-insurance, according to Mr. Schauer's office.