FLANAGAN’S RESTAURANT OWNER WHO USED TWO SETS OF BOOKS TO UNDER-REPORT GROSS RECEIPTS WAS TRIPPED UP BY A FACT-SHEET USED TO BROKER SALE OF THE BUSINESS

 The dilemma faced by business owners who cheat on taxes: They don’t want to pay tax based on their true gross receipts but they want to be paid full price when they sell the business.  What to do?

Flanagan’s Restaurants owner John Psihos’ solution was to keep two sets of books in his scheme to cheat on taxes.  For the years 2001 through 2004 he substantially under-reported his gross receipts from Flanagan’s.  He pleaded guilty to four counts of making false statements in his tax return (i.e., filing false returns).  He was sentenced to 24 months imprisonment and ordered to make restitution in the amount of $837,724, which was the determined amount of tax loss to the government from his fraud.

He appealed his sentence on several grounds but the Seventh Circuit Court of Appeals upheld the sentence and order of restitution finding no clear error in the lower court’s rulings.  (U.S. v. John Psihos, 7th Cir. Decided 6-15-12)

How was Psihos caught?  As summarized by the Seventh Circuit:

  • The IRS became suspicious when it obtained a fact-sheet prepared by a broker for marketing the restaurant for sale.  The fact sheet listed average monthly gross receipts of $170,000, average annual receipts of $2,040,000, and average yearly net profit of $554,840, which greatly exceeded that reported in his returns.
  • IRS began an undercover operation in which Special Agents posed as a husband and wife seeking to buy the restaurant chain. They met with Psihos three times in April and May of 2005.  Psihos explained to them how kept track of the actual receipts.
    • Each night managers would bring to him envelopes with all of the money, receipts, register tapes and pay-out information.
    • He would provide the information to one manager who would prepare a weekly summary report.  These were shown to the undercover agents along with the envelopes.
    • Psihos told the agents that he had the records showing what he was “actually getting” from the restaurant going back to 2001.
    • On May 31, 2005, agents executed a search warrant at one of Psiho’s restaurants and seized among other items, the weekly summary sheets.
    • Later they seized from a storage shed the envelopes detailing Flanagan’s nightly sales and cash payouts.
    • IRS revenue agents reviewed the weekly summary sheets and cross-referenced those figures with the nightly figures listed on the envelopes.
    • Based on the records the revenue agents calculated the gross receipts actually collected at Flanagan’s for the tax years 2001-2004.
    • They then calculated the net profit and tax due for each year.

Psihos, among other rejected arguments, asserted that the tax loss was incorrect because the calculations did not take into account certain deductions which he could have but did not claim in his tax returns.  These alleged deductions were cash amounts paid to:

  • DJ/ promoters from door charges
  • Wages
  • Amounts transferred to his other restaurants
  • Payments to his other restaurants for food supplied to Flanagan’s.
  • And the cost of complimentary drinks and food.

Taking these cash payments into account would reduce the tax loss to only $22,292 compared to the determined tax loss of $837,724.

The only evidence of these payments was a trial chart summarizing Psihos position on the calculation of the tax loss.  The District Court gave Psihos credit only for the cash payments listed on the envelopes and rejected the other cash payments because the payments were unsubstantiated and amounted to “unclaimed deductions” which do not enter into the calculation of the tax loss under the sentencing guidelines.(citing U.S. v. Chavin, 316 F.3d 666(7th Cir. 2002).

The Seventh Circuit affirmed stating:

The (sentencing) guidelines state that “tax loss is the total amount of loss that was the object of the offense.”  § 2T1.1(c) (1). We take that phrase “the object of the offense” to mean that the attempted or intended loss, rather than the actual loss to the government, is the proper basis of the tax-loss figure…Reference to other unrelated mistakes on the return such as unclaimed deductions tells us nothing about the amount of loss to the government that his scheme intended to create.” (Chavin at 677)

LESSONS TO TAKE FROM THIS CASE

  1. You can’t have it both ways.  Don’t shortchange the Treasury and don’t boast of your higher sales to potential buyers. Those buyers may be special agents.
  2. When you make your bed, you’ll have to sleep in it.  Not claiming cash deductions paid from unreported cash receipts creates a tangled web from which you won’t be able to escape.
  3. Make cogent arguments, not whimsical ones.  Claiming that you kept two sets of books and followed elaborate procedures to under-report $22K over four years is not very credible.  The Seventh Circuit did not discuss the speciousness of this argument but the District Court must have considered it very unlikely.
  4. Cash businesses should fastidiously record cash receipts and payments contemporaneously under a consistent accounting process that will evidence the receipts and payments.
  5. As Baretta, said in the TV series of the name, “Don’t do the crime if you can’t do the time.”

© 2012 by Robert S. Steinberg, Esquire
All rights reserved

This entry was posted in TAX, TAX CRIMES and tagged , , , , , , . Bookmark the permalink.

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