Originally published on Forbes.com Feb 7th, 2014
I’m not sure that “gentlemen’s club” is the greatest euphemism ever coined, but it is certainly up there. “Strip joint” captures the essence much better. Nonetheless, Potter’s Pub fancied itself a “gentlemen’s club”. John Potter, the long term owner was in Tax Court recently. Things did not go well for him, although since he had already been criminally convicted, the fraud penalty was more a matter of adding insult to injury.
Strip joint cases seem to be irresistible to the tax blogosphere, so I will just focus on a few aspects that I find of interest. Tony Nitti has already posted on Going Concern, a bastion of mature commentary on all matters accounting including tax.
How To Make Money In The Gentlemen’s Club Business
By way of background, the decision explains the various cash streams that the owner of a gentlemen’s club participates in.
Potter’s Pub was a cash-based business that derived receipts from food and drink charges run through the cash register, door cover charges, juke box moneys, pool table receipts, and moneys paid to the pub by the dancers for the privilege of “dancing.”
So the dancers are paying the club, not the other way around.
If you want a sense of what it was like at this particular “gentlemen’s club”, you can check out the worst video clip I have ever referenced – or not.
The Downside To Not Reporting All Your Income
When you build a profitable business, not only are you getting the profits as you go along, you are also creating a valuable asset. Valuations tend to be based on business profitability. It is not unusual for the valuation to be a multiple of EBITDA – Earnings Before Interest Taxes Depreciation And Amortization. In the case of Potter’s Pub, the records supporting tax filings indicated that EBITDA was $0, which would make for a very low valuation.
Oh What A Tangled Web We Weave, When First We Practice To Deceive
Mr. Potter’s solution to the problem of $0 EBITDA was his downfall.
In December 2006 IRS special agents engaged in an undercover investigation of Potter’s Pub, posing as buyers interested in acquiring the business. Petitioner assured the agents that Potter’s Pub was much more profitable than it appeared. He explained that he deposited in the corporate account only enough of the business revenues to cover its expenses and that he wired the balance of its revenues to his personal bank account in Florida. These wire transfers were structured in amounts less than $10,000 to avoid reporting obligations by the bank to the IRS. In reality, petitioner told the agents, Potter’s Pub grossed more than $1 million annually and he took home between $400,000 and $520,000 each year.
He made an interesting observation to the supposed buyers.
Petitioner showed the agents clandestine sales ledgers for 2003 and 2004 that supported the gross receipts he claimed, acknowledging that it might have been unwise to maintain documentary evidence of his skimming.
Yah think?
I have to editorialize just a bit here. Thankfully, for the good of humanity, I have a more or less chaotic good alignment. The reason to be thankful for that is that I believe that I have the potential for being a consummate villain. Had I been Mr. Potter, I would have told the “potential buyers”, that they should make their own assessment of the profit potential of the operation from observation. If I felt some sort of compulsion to keep a record of my ill-gotten gains, the last place I would have kept it was at the scene of the crimes, so to speak.
The Fraud Penalty
The fraud penalty (Code Section 6663) is a pretty nasty one – 75%. Mr. Potter argued that he should not be subject to the fraud penalty because he “went to extraordinary lengths to cooperate with the Government.” The Tax Court was dismissive of that defense:
But he began to cooperate only after he knew that the jig was up. It was only after the search of his business turned up the illicit sales ledgers and $200,000 in unexplained cash that petitioner provided his accountant with the books and records needed to prepare amended returns. These efforts may have helped petitioner in his negotiations with the Department of Justice in his criminal tax case. But they do not purge the fraudulent intent that accompanied the original filing of his false individual tax returns for 2002-05.
I thought “the jig was up” was a nice touch.
That’s How They Go Al Capone?
There are a lot of concerns about the whole “gentlemen’s club” phenomenon. The greatest one is probably the exploitation of the “dancers”. This can be facilitated by the fiction that they are independent contractors. I doubt that there are any statistics on the level of dancer tax compliance, although you can find groups like We Are Dancers, which encourage tax compliance.
There is even a guide published “How Do Strippers File Taxes”. One thing that is not mentioned in the material is that, in principle, if the “independent contractor” fiction were real, the dancers should be sending 1099s to the club owners and the bouncers that they share tips with. I doubt that I could give that advice with a straight face.
In September a federal judge ruled that the dancers at Rick’s, an upscale club near the Empire State Building were protected by minimum wage laws. Disgruntled dancers who have themselves been tax compliant may want to consider filing form SS-8 to cut their self-employment tax in half.
There is probably enough money in the “gentlemen’s club” business that it would survive a concerted IRS effort to whip it into compliance, but the effort might have the effect of putting the worst actors in the business, who are involved in human trafficking under the microscope.
The IRS has just over 90,000 working for it. Only about 20,000 are involved in enforcement, mostly revenue agents, whose basic education is to be accountants. Congress is punishing the IRS with budget cuts, because of the “scandal” involving the supposed targeting of right-leaning 501(c)(4) groups.
Wouldn’t it be great if the people on the right, social conservative, and the left, some, although not all, feminists who have no use for “adult entertainment” or “pornstitution” formed a coalition to fund a couple of hundred extra IRS enforcement people to focus on “gentlemen’s clubs” and the like? Even better, send the whole politics by exempt organizations problem over the Federal Election Commission and let the IRS stick to collecting taxes with a little extra focus on the sleazy.
You can follow me on peterreillycpa.