August 23, 2018

Two weeks ago federal prosecutors announced criminal tax charges against the owners of five Chicago-area restaurants as part of an ongoing federal investigation into the underreporting of gross receipts using sales suppression software. The charges allege that the defendants willfully avoided paying the full amount of federal taxes by reporting gross receipts that were substantially lower than the true amounts. This case appears to be the largest and perhaps most significant federal criminal case to date against businesses that use sale suppression techniques to conceal revenue from tax authorities.

Commonly called “zappers,” sales suppression software programs run on a point-of-sale computers or cash registers and are used to secretly delete some or all cash transactions. The result is that the company’s books appear to be complete and accurate but are in fact false because they reflect fewer sales than were actually made. An article published by BNA last year reported that tax-zapping software costs states $21 billion in taxes annually and that 30 percent of the electronic cash registers, or point-of-sale systems, in the United States have a zapper installed.

To date, state attorneys general and revenue departments have taken the lead in cracking down on businesses that use sales suppression techniques. In the last two years, state authorities in Washington, Minnesota, Michigan, Illinois and Connecticut have successfully prosecuted criminal cases against businesses and their owners — primarily in the restaurant industry. Washington’s attorney general has been particularly aggressive in this area, filing earlier this year what he called the largest sales suppression case in the state’s history and two years ago what he called the “first-of-its-kind” zapper prosecution. In addition, numerous states have also passed laws outlawing the use of zappers and other types of sales suppression devices.

The Internal Revenue Service has been conspicuously absent from efforts to prosecute businesses and their owners for use of zappers, leading many to wonder whether the IRS would ever play a role or leave the anti-zapper efforts to the states. The only notable federal case to date involved John Yin, a salesman for a company that sold sales suppression software who was charged in December 2016. Yin sold zapper software to businesses in the Seattle area from at least 2009 through mid-2015. He pleaded guilty to assisting in the widespread distribution of zappers to dozens of customers in and around Seattle over the course of several years, and was eventually sentenced to 18 months in prison. While we expected a wave of federal prosecutions to follow the Yin case, that has not yet materialized (at least not publicly).

The federal charges in Chicago are the first federal charges in a zapper case since the Yin case. Five separate, and for the most part unrelated, business owners were charged in what was described as a “federal investigation targeting underreporting of gross receipts.” It appears that the federal investigation may have been prompted by a prior state case against one of the defendants. In August 2017, Illinois Attorney General Lisa Madigan announced charges against Sandra Sanchez, owner of Cesar’s Restaurant in Chicago. In that case, Sanchez was charged with theft and tax evasion for defrauding the state out of more than $100,000 by using a sales suppression device to underreport more than $1 million in sales to the Illinois Department of Revenue. The Attorney General alleged that between January 2012 and October 2015, Sanchez used a zapper to falsify electronic sales records to avoid paying the full amount of sales and use taxes to the state each month. The Sanchez prosecution was the first zapper case prosecuted in Illinois, following the state’s enactment of anti-zapper legislation in 2013. The press release announcing the charges noted that IRS criminal investigators assisted in the investigation. The Illinois Attorney General has not issued any subsequent press releases regarding this case, so it is not clear whether Sanchez has pleaded guilty or will be proceeding to trial or is cooperating with investigators.

Sandra Sanchez was one of the five individuals charged federally in Chicago two weeks ago. And the press release announcing the charges noted that she was charged by information, not by indictment, indicating that she has likely agreed to plead guilty. Also charged at the same time was Israel Sanchez, owner of a restaurant called Cesar’s on Broadway. Like Sandra Sanchez, Israel Sanchez was charged by information, indicating that he too is likely to plead guilty.

Given the prior state charges filed against Sandra Sanchez, and the apparent forthcoming federal guilty pleas by both Sandra Sanchez and Israel Sanchez, it may well be the case that one or both of these individuals are cooperating and assisting state and federal investigators with their zapper investigation. Indeed, last week’s Justice Department press release indicates that the federal investigation is ongoing and therefore may be more broadly focused than the five individuals charged. Indeed, the special agent-in-charge of the IRS Criminal Investigation Division in Chicago warned that these charges are just tip of the iceberg, and that cash-intensive businesses using zappers are at risk: “This is only the beginning. I want to warn those restaurants, gas stations, convenience stores and other establishments that are currently using or thinking of using sales suppression software, that we are on to you and your methods.”

Three other individuals were charged in Chicago last week: Shuli Zhao, owner of Katy’s Dumpling House in Westmont; Chun Xu Zhang, owner of Sushi City in Downers Grove; and Quan Shun Chen, owner of Hunan Spring in Evanston. It is not clear from the press release and charging documents whether these three individuals are related to each other or if they are related to the other two individuals charged, Sandra Sanchez and Israel Sanchez. Unlike the Sanchezes, these three business owners were charged by indictments, indicating that they are contesting the charges and are not pleading guilty.

The Chicago cases appear to be the most significant federal criminal case alleging use of tax zapper technology to date. As noted, for the past several years, state authorities have been taking a lead role in investigating and prosecuting businesses that use sale suppression technology. The Chicago cases are significant not only because they represent the first federal charges against business owners in many years (as opposed to the Yin case, which involved a zapper salesman) but also because they appear to be part of a larger investigation of Chicago-area businesses that use zappers. With guilty pleas expected from two of the individuals charged, at least one of those individuals likely cooperating, and the investigation ongoing, we anticipate seeing more federal charges arising out of this likely widening-probe.

Reprinted with permission from Law360. (c) 2018 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.

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