Someone once said that the only
things certain in life are death and taxes.
This case, to a degree, disproves the latter. The Department of Taxes gets to “guesstimate”
taxes when business records are questionable.
Taxpayers, husband and wife, own and
operate a small bar and grill as an S-corporation (which means that only the
profits passed to the owners are taxed; this is known as a pass-through basis in
the trades). The records they kept were
not exactly impeccable. In fact, there
were some—perhaps a lot of—discrepancies.
The Department of Taxes (Department) audited the corporation and found an
outside-the-norm cost-of-goods-to-gross-receipts ratio. During its investigation, the Department
found some discrepancies between cash-register receipts and handwritten
accounts. Long story short—according to
the Department, something didn’t add up.
So the Department assessed
additional taxes for three years on meals and alcohol based primarily on its
determination of appropriate cost-of-good-to-gross-receipts ratios. Taxpayers requested an administrative
hearing, which did not go in their favor.
An appeal to the civil division ensued, where the trial court upheld the
assessment. And . . . yep, you guessed
it . . . that’s how we end up at the SCOV.
The standard of review is as follows
in bulleted form:
·
Same standard as applied in the
intermediate appeal at the superior court;
·
Commissioner’s decision is reviewed independent
of the superior court’s findings and conclusions;
·
Commissioner’s findings are not set
aside unless clearly erroneous; and
·
Taxpayer’s burden is to prove that
the assessment is erroneous by a “clear and convincing” showing.
“An uphill battle” is putting it
mildly.
Taxpayers first make a statutory
argument that the Commissioner has no authority to estimate taxes except when a
taxpayer has failed to make a return. A
“however” and “clearly” in the SCOV’s response to this argument shows us the
direction we’re heading. The SCOV
explains that the very next subsection provides the Commissioner authority to do
what he did here. Basically, the SCOV
says that if a return is sketchy, then it’s pretty much the same thing as not
filing a return “as required and the Commissioner has authority to correct
that. The Taxpayers’ “But other courts
say!” argument goes nowhere.
Taxpayers’ next argument is that the
estimation methodology was flawed. This
is an interesting argument because as anybody who’s been to more than three
bars in their lifetime knows, drink strength can vary tremendously. Husband testified that the average pour of a
liquor drink is four ounces. But the
assessment was based on industry averages—where an average drink is
one-and-a-half ounces. Apparently, the
auditor was also once a bar manager.
[Editorial Note: judging from the 1.5 ounces claim, probably at a chain
restaurant where the drinks, in the colloquial sense, suck—this illustrates the
importance of expert testimony in certain situations and expert barkeeps in
others]. There is also an issue with the
cash register being broken and handwritten adjustments having been made to the
register tape. At any rate, the SCOV
goes the not-clearly-erroneous-to-give-more-weight-to-the-Department’s-witness-so-we’re-just-gonna-move-on
route.
The SCOV reasons that the Department’s
method of reconstructing gross receipts is commonly accepted, and so concludes
that “Taxpayers have not shown by clear and convincing evidence that the method
was arbitrary or invalid.”
The SCOV notes that the Taxpayers
had a duty to maintain reliable records.
Because the Taxpayers did not, the SCOV reasons that the Commissioner’s
calculation of taxes due was properly completed. The SCOV holds that the Taxpayers have not
met their burden of demonstrating the assessments are incorrect, and upholds
the Commissioner’s determination.
So if you own a business, make sure
to keep airtight books. You don’t want
the Department of Taxes second-guessing your
filings.
That’s right. I’m here all week, folks. Don’t save your applause until the end.
Interesting information. I'm glad I don't practice tax law.
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