Restaurateur's Attempt to Pin $1.6 Million Omission on Tax Accountant Fails.

(Parker Tax Publishing April 10, 2015)

The Tax Court determined a restaurant owner had vastly underreported his businesses income for multiple years, and found the taxpayer's attempt to shift blame to his accountant unconvincing. The court determined the omission was fraudulent, noting the taxpayer met multiple "badges of fraud," and imposed a 75 percent penalty. Musa v. Comm'r, T.C. Memo. 2015-58.

Alaa Musa formed Casablanca Restaurant, LLC (Casablanca) as a single-member limited liability company in 2005. The restaurant used an industry standard point-of-sale system to fulfil orders and record sales reports from cash and credit card purchases. Musa kept diligent records of credit card receipts, but he would frequently throw away the records of the cash receipts. Musa never deposited more than a minimal amount of Casablanca's cash receipts into the operating account and would generally take the cash home with him.

In early 2006, Musa hired J&M Accounting & Tax Services (J&M) to provide accounting and tax services for Casablanca. J&M prepared monthly sales tax returns for Casablanca based on sales numbers Musa provided over the phone. Musa did not provide J&M with copies of daily sales reports, and the sales numbers he provided were far below what was reflected on the reports.

The IRS audited Casablanca for 2006 to 2009, and issued a notice of deficiency. The audit found Musa had vastly underreported the restaurant's income in excess of $1.6 million, and the IRS assessed a civil fraud penalty under Code Sec. 6663(a).

Code Sec. 6663(a) imposes a 75 percent penalty equal to any part of any underpayment of tax if the underpayment is attributable to fraud. Courts have developed a nonexclusive list of "badges of fraud" to demonstrate fraudulent intent (Bradford v. Comm'r, 796 F.2d 303 (9th Cir. 1986)).

The Tax Court found multiple badges of fraud were present in Musa's conduct. For all the years the IRS audited, the court determined Musa: (1) underreported his income, (2) maintained inadequate records, (3) concealed income and assets from both his accountants and the IRS, (4) failed to file Forms W-2 and Forms 1099-MISC, (5) filed false documents, (6) failed to make estimated tax payments, and (7) dealt extensively in cash. He also failed to cooperate with revenue agents during the audit, refusing to comply with multiple information document requests. Finally, Musa offered inconsistent and implausible explanations to the IRS and to the Tax Court for his behavior.

Musa argued that his accountant at J&M was to blame for the inaccuracies in his tax returns, claiming that J&M had access to his financial records and chose to underreport his income. The tax court found this unconvincing and implausible, noting that J&M did not have access to the point-of-sale reports until after the audit began, that Musa failed to disclose all of his bank accounts, and that he gave no explanation as to why his accountant would be motivated to prepare grossly inaccurate returns. Further, the court noted that under Metra Chem Corp. v. Comm'r, 88 T.C. 654 (1987), as a general rule, taxpayers cannot avoid the duty of filing accurate returns by placing responsibility on a tax return preparer.

Considering his conduct, the Tax Court found that Musa was liable for the Code Sec. 6663 civil fraud penalty for each year at issue.

For a discussion of the fraud penalty on underpayments of tax, see Parker ¶262,125. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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