IRS – 1 Flanagan’s – 0

June 27, 2012 — Leave a comment

Tax Court, even if you win, you can still end up paying. To win in Tax Court, you had to have lost on the audit, lost on the appeal and then lost on the appeal a second time, all of which is pretty expensive. In a recent Seventh Circuit decision, Mr. John Psihos was appealing his two-year prison sentence and restitution order in the amount of $837,724. He lost.

The case concerned the operation of Flanagan’s Bar in Chicago. Around 2005, he explored selling Flanagan’s going so far as to have it advertised. A couple showed significant interest in Flanagan’s and met with him three times. Mr. Psihos’s tax saving plan was elegant in its simplicity. He simply did not report his entire gross income. Besides this illegitimate strategy, the plan has another flaw – if he decided to sell the business, its stated value would not match up to its actual worth. Mr. Psihos addressed that contingency by keeping extremely detailed records of his actual cash receipts.

As it turned out, the couple was not actually interested in buying Flanagan’s, however they were interested in its tax returns and cash flow statements. The couple was actually a pair of undercover IRS criminal investigators and analyzed the receipts and cash flows from Flanagan’s. The Chicago-based bar understated its income by roughly $2.5 million between 2001 and 2004.

The essence of Mr. Psihos’s appeal was that the tax loss that formed the basis of his sentence and restitution was overstated. There is this subtle distinction between tax loss for purposes of sentencing and tax loss for purposes of restitution. One is based on what you were trying to evade and the other on what you actually succeeded in evading. Mr. Psihos tried to argue that a large portion of the unreported receipts were spent on deductible expenses. Mr. Psihos claimed the tax loss was just over $20,000.

The Court did not buy the argument for either sentencing or restitution:

First, there is absolutely no basis to determine the amount of purported cash payments because, even under Psihos’s version of events, he did not keep track of the various claimed outlays. Second, and relatedly, if Psihos had truly shifted cash to Café Oceana—the largest reduction he seeks—then he would be entitled to a reduction in restitution only if Café Oceana had reported those cash inflows as revenues; yet Psihos lacks the corresponding records from Café Oceana showing its receipt of those funds, and in turn its reporting the money as revenue to the IRS. Third, Psihos kept no record of the cash payments to bouncers and promoters, which in turn creates a near certainty that the government suffered a loss of taxes owed by those recipients.

JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.

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