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The Green Chef is an exclusive restaurant in your city. Reservations are difficult to secure and the menu is expensive. The owner, Chef Jorge, is

The Green Chef is an exclusive restaurant in your city. Reservations are difficult to secure and the menu is expensive. The owner, Chef Jorge, is rumored to be running an illegal gambling operation on the side, with revenue flowing through the restaurant to ensure there will be appropriate reporting of revenue and thus, no consequences for tax fraud. 

Donna prepares the corporate tax return for the Green Chef, based on amounts from Chef Jorge's computerized general ledger, which he shares with her at year-end. After 10 years of working for Chef Jorge in the preparation of his corporate tax returns, she feels she understands the business fairly well.

Donna, a licensed CPA in the state and a member of the AICPA, heard stories of the gambling operation, but having worked with Chef Jorge for so long, she dismisses the accusations as rumors. This year, however, the business showed a sharp increase in net income as well as revenue, including a large tax liability. Chef Jorge did not complain about the taxes due, as he typically did when he first started.

Here is the information that Donna worked with:

Information for the prior five years
Year 2011 2012 2013 2014 2015
Revenue $750,000 $875,000 $1,200,000 $1,700,000 $2,000,000
Cost of Goods Sold 240,000 262,500 324,000 442,000 400,000
Operating Expenses 375,000 410,500 506,250 690,500 625,000
Net Income Before Taxes $135,000 $202,000 $369,750 $567,500 $975,000
Income Tax (34%) $45,900 $68,680 $125,715 $192,950 $331,500

Required:

  1. What caused Donna to question her client's tax return?
  2. Using data provided, does Donna have any support for her concerns?
  3. What is Donna's responsibility, under Circular 230 and other tax preparer ethics guidelines, regarding her suspicions?
  4. What were the "red flags of fraud" that you noticed as you read through the case?
  5. What are the fraud triangle issues associated with The Green Chef restaurant?

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