Restaurant Owner's Cash Skimming, Other Misdeeds, Were Civil Tax Fraud

Transcription

1 Restaurant Owner's Cash Skimming, Other Misdeeds, Were Civil Tax Fraud Musa, TC Memo The Tax Court has held that a restaurant owner who did not report significant amounts of cash that he skimmed from his restaurant, lied to his accountant and payroll service company, and committed other misdeeds, was liable for the civil fraud penalty with respect to his entire underpayment. The Court also applied the Cohan rule to allow some of his business deductions but not others. If any part of any underpayment of tax required to be shown on a return is attributable to fraud, Code Sec. 6663(a) imposes the civil fraud penalty, a penalty equal to 75% of the portion of the underpayment which is attributable to fraud. Code Sec. 6663(b) provides that once IRS establishes that any portion of the underpayment is due to fraud, the entire underpayment is to be treated as attributable to fraud except with respect to any portion that the taxpayer establishes, by a preponderance of the evidence, is not attributable to fraud. IRS bears the burden of proving fraud by clear and convincing evidence. ( Code Sec. 7454(a) ; Tax Court Rule 142(b)) To satisfy his burden, IRS must show: (1) an underpayment of tax exists, and (2) that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. (Parks, (1990) 94 TC 654 ) Because direct evidence of fraud is rarely available, fraud may be proved by circumstantial evidence and reasonable inferences from the facts. Courts have developed a nonexclusive list of factors, or "badges of fraud," that demonstrate fraudulent intent. (Niedringhaus, (1992) 99 TC 202 ) These badges of fraud include:... understating income, 1

2 ... maintaining inadequate records,... implausible or inconsistent explanations of behavior,... concealment of income or assets,... failing to cooperate with tax authorities,... engaging in illegal activities,... an intent to mislead which may be inferred from a pattern of conduct,... lack of credibility of the taxpayer's testimony,... filing false documents,... failing to file tax returns,... failing to make estimated payments, and... dealing in cash. Although no single factor is necessarily sufficient to establish fraud, the combination of a number of factors constitutes persuasive evidence. Under the Cohan rule, where a taxpayer is able to demonstrate that he has paid or incurred a deductible expense but cannot substantiate the precise amount, a court may estimate the amount of the expense if the taxpayer produces credible evidence providing a reasonable basis for the court to do so. (Cohan, (CA ) 8 AFTR 1055) The Court is not permitted to use the Cohan rule to estimate certain expenses under Code Sec. 274, and the taxpayer must strictly substantiate such expenditures. ( Code Sec. 274(d) ) Facts. The taxpayer, Mr. Musa, owned Casablanca Restaurant, a Schedule C business. Casablanca used Micros Systems Inc. (Micros), an industry-standard point-ofsale system, to fulfill customers' food and drink orders. Casablanca's staff entered customers' orders into computer terminals. The Micros computers then routed each order to the kitchen or bar, as applicable. Additionally, each order was recorded by Casablanca's computer. At the end of an employee's shift the 2

3 Micros system printed a "checkout report" that totaled the gross receipts from an individual waiter's shift, including bills paid by cash or credit card. Musa printed sales reports from Micros and stapled the credit card receipts to each sales report. Musa retained all of the credit card receipts. Credit card payments were automatically deposited into Casablanca's business operating account. Musa threw away the cash receipts and checkout reports. He generally took the cash received home with him each night and placed it in a safe in his residence. During the years at issue, , Musa never deposited more than a de minimis amount of Casablanca's cash receipts into the operating account or any other bank account. Before trial, the parties entered into a stipulation of settled issues where they agreed that Casablanca's gross receipts were underreported by nearly $2 million for the years at issue. Musa claimed wage deductions of $207,150 on Casablanca's 2010 Schedule C, but the records of his payroll service reflected wages paid of only $131,250. IRS disallowed the $75,900 difference. Casablanca's original payroll returns reflected the $131,250. In 2013, Casablanca submitted amended payroll returns that showed the $207,150; the difference was amounts that Musa paid his relatives in cash, that he didn't report to the payroll service. Mr. Jobin was Musa's accountant. Jobin prepared monthly sales tax returns for Casablanca. Musa provided Jobin with Casablanca's sales numbers monthly by telephone. Musa did not provide Jobin with copies of the Micros daily sales reports until after the IRS audit began in The sales numbers Musa provided to Jobin were far below actual sales as reflected on the Micros reports. Jobin used the monthly sales numbers that Musa called in to prepare Musa's Schedules C reporting Casablanca's gross receipts. 3

4 In addition to misleading Jobin about Casablanca's sales, Musa did not disclose all of his bank accounts to Jobin, including the bank account into which credit card payments were deposited and his personal account. Early in the relationship between Casablanca and Jobin and before the audit, Mr. Jobin told Musa that he should deposit Casablanca's cash receipts into a bank account, but Musa admitted at trial that he did not follow this advice. Mr. Jobin also told Musa that all employees should be added to Casablanca's payroll, including Musa's family members. Musa chose not to heed Mr. Jobin's advice in this regard. Musa switched to a different accounting firm to handle the IRS audit. He continued the practice of not reporting the actual sales from the Micros reports and skimming cash when he reported sales figures to Mr. Sturm, the new accountant. During the audit, Casablanca claimed new deductions for car and truck expense, meals and entertainment and travel, but Musa submitted no documentation that would substantiate these additional deductions. During the audit, Musa also claimed additional deductions for nonemployee compensation. Samantha Christensen was a belly dancer who has performed at Casablanca most Friday nights since October She was paid $100 for each performance. Elijah Jansen was a former Casablanca manager. Mr. Jansen claimed that Casablanca regularly recruited passersby to conduct various cleaning duties at Casablanca. These individuals were paid in cash, but Mr. Jansen could not state whether Casablanca maintained records of the amounts paid to these individuals. Yusuf Abbasi scheduled DJs to perform at Casablanca since September Mr. Abbasi claimed that the DJs performed every Thursday, Friday, and Saturday night and were paid $150 in cash for each performance. Mr. Abbasi was not aware of any records that Casablanca kept for the amounts paid to the DJs. 4

5 The Court held that the civil fraud penalty applied to Musa's entire underpayment. The Court first noted that the fact that the parties stipulated that Musa failed to report significant sums of gross receipts from Casablanca for each year at issue established that there was an underpayment. The Court then looked at nine factors-understatement of income; inadequate maintenance of records; implausible or inconsistent explanations of behavior; concealment of assets or income; failure to cooperate with tax authorities; failure to file tax returns; filing false documents; and failure to make estimated tax payments; and dealing in cash-and found that all nine supported a finding of fraud. As to the understatement of income, Musa argued that the underreporting of income was not intentional but was instead due to carelessness and recklessness, which he argued negated a finding of fraudulent intent. Musa attempted to blame Mr. Jobin for the inaccuracies in his tax returns by arguing that Mr. Jobin had access to his financial records and the Micros reports but for some unspecified reason chose to underreport Musa's income. The Court found Musa's arguments to be unconvincing for several reasons. First, Mr. Jobin credibly testified that he did not see the Micros reports until after the commencement of the audit, and, further, Musa failed to disclose all of his bank accounts to Mr. Jobin. Musa did not offer any explanation as to why Mr. Jobin would be motivated to prepare grossly inaccurate returns. Second, the underreporting continued after Musa changed accountants and enlisted Sturm to prepare his tax returns. Citing Temple, TC Memo , the Court said that consistent failure to report substantial income over several years is highly persuasive evidence of fraudulent intent. As to inadequate maintenance of records, Musa admitted at trial to the following: 5

6 (1) destroying cash sales receipts, (2) excluding his family members from payroll and paying them in cash, for which he kept no records, (3) failing to keep any records relating to amounts paid in cash to janitors and performers, (4) failing to keep any records relating to vehicle expenses, and (5) failing to keep records for claimed travel, meals, and entertainment expenses. Musa's petition alleged that the Micros reports were "unreliable" and "unreconciled" and therefore that IRS's reliance on them to reconstruct Musa's gross income was "illogical and erroneous." But, later, he argued that he failed to keep cash receipts because the Micros reports captured all of the incoming sales and thus there was no need to keep records of cash sales. The Court pointed out the inconsistency in Musa's arguments regarding the Micros reports. Musa also attempted to explain his destruction of cash sales records by arguing that keeping records of cash sales would have been too onerous, because doing so would have required "dozens upon dozens" of boxes. The Court said that Musa's testimony on this point seemed hyperbolic, given that his testimony reflects that credit card receipts from the five years at issue filled only eight boxes in his office. The Court noted that Musa's failure to file Forms W-2 and 1099 on behalf of family members and nonemployee contractors who were paid in cash supported a finding of fraudulent intent. But, it rejected IRS's argument that Musa's waiting to file amended Forms 941-X until 2013 and 2014, after purportedly discovering the errors in 2012, supported a finding of fraudulent intent. The Court said that the Code does not generally require taxpayers to file amended returns. Taxpayers may choose to file amended returns to correct errors on original returns, but such action is not generally mandated by the Code or the regs. Musa filed original Form 941 returns that were grossly inaccurate, but he nevertheless filed those returns. 6

7 The failure to file amended returns does not support a finding of intent to evade taxes. While finding that the taxpayer did not provide evidence upon which the Court could base a Cohan rule deduction for wages paid to his relatives, the Court did allow, under the Cohan rule, some deductions for payments of nonemployee compensation. It said that Ms. Christensen credibly testified that she was paid $100 for belly dancing most Friday nights at Casablanca beginning in Accordingly, the Court allowed Musa an additional deduction of $5,200 for each year at issue for the amounts paid to Ms. Christensen. Similarly, Mr. Abbasi credibly testified that Musa paid DJs $150 for performing on Thursday, Friday, and Saturday nights. However, the Court said, Mr. Abbasi was not hired to coordinate the DJs until 2009, and so it could not rely on his testimony for tax years for which he did not have firsthand knowledge. Accordingly, the Court allowed Musa allowed an additional deduction of $23,400 for both 2009 and However, the Court said, Mr. Jansen's testimony did not give the Court a reliable basis upon which to estimate the amounts paid to itinerant cleaners. 7