Superior Point Of Sale Software Does Not Mix Well With Skimming

This post was originally published on Forbes Apr 20, 2015

The Micros Systems Inc point of sales system for restaurants seems pretty slick.

MICROS provides comprehensive restaurant point-of-service (POS) solutions that can be scaled to meet the needs of every type and size of restaurant, whether you operate a single restaurant or hundreds. Our modular restaurant POS systems can easily be expanded as required, and can fit the demands of quick-service, fast casual, and full-service restaurants, as well as catering, pubs and bars.

That "every type" of restaurant claim is not perfectly accurate.  Restaurants where there is significant skimming of cash receipts going on are not well served by a sophisticated POS system like Micros. That was the lesson that Alaa I. Musa learned in Tax Court last month.  The IRS was after him for the 75% fraud penalty, which is as bad as it gets short of losing your liberty. Unlike the accuracy penalty, where the taxpayer has the burden of providing a good excuse for understatement, the burden is on the IRS to prove fraud.  Thanks to the superior POS system, that was less of a challenge for the IRS.

Here's Looking At You Kid

Mr. Musa's restaurant, Casablanca,  has middle eastern cuisine and the occasional belly dancer. No gambling, as far as I have been able to determine.

The shocking thing is the skimming I guess. Mr. Musa let the credit card receipts go into his bank account but when it came to actual cash

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 petitioner never deposited more than a de minimis amount of Casablanca's cash receipts into the operating account or any other bank account.

Some Detailed Records That Went Nowhere

Casablanca used Micros Systems Inc. (Micros), an industry-standard point-of-sale system, to fulfill customers' food and drink orders. Casablanca's staff entered customers' orders into computer terminals after entering in a four-digit personal identification number unique to each staff member. The Micros computers then routed each order to the kitchen or bar, as applicable. Additionally, each order was recorded by a central computer in an office below the restaurant. 

At the end of an employee's shift the 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. The checkout report indicated the amount of tip income due to a waiter, who would then receive an equivalent amount of cash. Any remaining cash and the checkout reports were turned over to management. During 2006 and 2007 petitioner printed daily sales reports from Micros and stapled the credit card receipts to each sales report. For 2008, 2009, and 2010 petitioner generated only monthly sales reports.

After closing the restaurant each night, petitioner stapled together and retained all of the credit card receipts in the event a customer paying by credit card disputed a transaction. Credit card payments were automatically deposited into Casablanca's business operating account, ending in 1909, at U.S. Bank (operating account). Petitioner threw away the cash receipts and checkout reports.

A Helpful Cousin

Mr. Musa thought it would be a good idea to buy the building he was operating in.  He approached his cousin, Jeff, a commercial relationship manager for PNC.  When Jeff reviewed Casablanca's tax returns, he was shocked, shocked at the restaurant's low profitability.  He asked Mr. Musa if he had any other records and was shown the Micros reports.  Jeff noticed some discrepancies. Yah think? He recommended that Mr. Musa change accountants and recommended a Mr. Sturm to replace Mr. Jobin who had prepared the previous returns without the benefit of the Micros reports.

Mr. Musa did not get around to hiring Mr. Sturm until after he got a notice that he was being audited.  Mr. Sturm prepared amended returns for 2006 through 2008 and original returns for 2009 and 2010 not using the Micros reports, but rather sales tax reports.  Although there was significantly more revenue on the amended returns, the final figures agreed to with the IRS were even higher.

Badges Of Fraud

Besides the substantial gross receipts omission, there were some issues about payroll to relatives and expenses, but they were not nearly as dramatic.  The IRS still had to prove fraud, though.  Mr. Musa was inclined to attribute the understatement of gross receipts to his inexperience and neglect on the part of his accountants.  Unfortunately for Mr. Musa, the accountants were not ready to fall on their swords for him.

As a result, gross receipts for Casablanca were underreported by $430,442, $412,481, and $463,371 for 2006, 2007, and 2008, respectively, the years for which J&M prepared petitioner's individual income tax returns. J&M has a policy of reviewing tax returns with clients before filing, explaining important items such as gross receipts and cost of goods sold, and allowing clients to correct any errors on the return. Mr. Jobin credibly testified that J&M would have done the same with petitioner, and petitioner never informed anyone at J&M that the Schedules C were inaccurate.

We find petitioner'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 audit and further, petitioner failed to disclose all of his bank accounts to Mr. Jobin. Petitioner does not offer any explanation as to why Mr. Jobin or J&M would be motivated to prepare grossly inaccurate returns. Additionally, petitioner cannot escape the duty to file accurate returns by shifting the blame to Mr. Jobin and J&M.

Just as there are lists of factors for whether a business activity is engaged in for profit or someone is an employee rather than, there is a list of factors that indicates fraud.  They are referred to as the "badges of fraud".

Over the years, courts have developed a nonexclusive list of factors that demonstrate fraudulent intent. These badges of fraud include: (1) understatement of income, (2) inadequate maintenance of records, (3) implausible or inconsistent explanations of behavior, (4) concealment of assets or income, (5) failure to cooperate with tax authorities, (6) engaging in illegal activities, (7) an intent to mislead which may be inferred from a pattern of conduct, (8) lack of credibility of the taxpayer's testimony, (9) failure to file tax returns, (10) filing false documents, (11) failure to make estimated tax payments, and (12) dealing in cash.

The Tax Court found nine of the twelve (the ones in bold) in Mr. Musa's case.

That was enough to support the 75% penalty.

What Was He Thinking?

I'm really puzzled as to why someone would put in a sophisticated POS system, if he is not going to be scrupulous about depositing all the receipts.  Of course the other alternative is "zapper" software, illegal in many states, that will allow you to have the benefits of a POS system while being able to manipulate your total sales figure to be consistent with what you decide to deposit.

Even if you are totally amoral, I can think of several reasons that doing something like that is a really bad idea (Like maybe illegal bootleg software will have other nasty features such as stealing credit card info built into it), but it seems slightly more sensible than having detailed records that demonstrate that you are skimming close to half your gross receipts.  What we really have here is another illustration of Reilly's Second Law Of Tax Planning - "Sometimes, it's better to just pay the taxes".