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IRS: Royce Gracie’s company fraudulently failed to report over $1.4 million in income

Royce Gracie could have more problems than originally reported with newly-discovered IRS tax fraud claims against his company, Khonkhor Enterprises, including a disallowed $338,871 expense deduction for The MMA Lab.

Troy Taormina-USA TODAY Sports

In January, Bloody Elbow broke the news of Royce Gracie's tax battle with the IRS over the agency's determination that he and his wife fraudulently evaded paying over $1.1 million in personal income taxes from 2007-2012 through the use of foreign bank accounts, wire transfers "used to pay for, among other things, renovations to their vacation property in Mammoth lakes, California, and personal credit card debts," hiding corporate income as "personal loans," and other means.

Bloody Elbow's original story reported numbers excluding credits, writing that as a result of the Gracies' alleged conduct they "appear to have reported annual tax liabilities of just $900, $2,545, $170, $0, $0, and $3,925 in 2007-2012." Bloody Elbow's tax expert believes that once credits the Gracies allegedly claimed such as the Earned Income Credit (a tax credit for the working poor) and Additional Child Tax Credit are included in the numbers above for 2008-2012, the situation looks even worse.

According to Bloody Elbow's tax expert, the Gracies' reported net tax liability after credits for 2008-2012 appears to be negative, meaning they effectively (and allegedly) asked the U.S. government to pay them instead of the other way around. To be more precise, Royce Gracie and his wife allegedly asked the U.S. government to pay their family a total of $13,440 over the five-year period from 2008-2012, according to our expert. That means someone who paid just $1 in federal taxes during 2008-2012, would've effectively paid thousands more to the U.S. government than the Gracies allegedly did during the same time frame.

If all this is true, it's bad enough to ask the government to pay you when you're a world-famous UFC Hall of Fame fighter with 55 Royce Gracie Jiu-Jitsu Networks across the globe and a wife who's a doctor of podiatric medicine, but Bloody Elbow recently discovered that the IRS also made two separate tax deficiency determinations against Gracie and his wife's company, Khonkhor Enterprises, one claiming negligence-related tax penalties, the other claiming both fraud and delinquency-related tax penalties.

In 2013, the IRS sent Khonkhor a Notice of Deficiency with a determination that the company owed an additional $76,755 in taxes for Khonkhor's fiscal year ended Mar. 31, 2010 plus a 20% penalty ($15,351) that was coded "Accuracy-related (Negligence)."

According to the Notice of Deficiency, the IRS determined that $11,325 in meals and entertainment expenses, $52,532 in travel expenses, $65,020 in office supplies expenses, and $10,048 in interest expenses "have not been shown to be an ordinary and necessary expense of [Khonkhor]. [Khonkhor] failed to substantiate 1) that the expenditures are deductible...or 2) that the expenditures were incurred for the purpose designated."

The deficiency notice also included adjustments for an unexplained $50,000 deposit in Malaga Bank, $77,753.97 in unexplained credit card payments, a $25,000 wire transfer from HSBC in Geneva, Switzerland, and a $10,000 wire transfer from Deutsche Bank in Beijing, China.

Based on all the determinations above, the IRS increased Khonkhor's taxable income through Mar. 31, 2010 by $219,229, resulting in $76,755 additional tax owed plus a 20% accuracy-related penalty due to what the IRS claimed was Khonkhor's negligence or disregard for the rules and regulations.

Then in 2015, the IRS sent Khonkhor another Notice of Deficiency, this time for tax years ended Dec. 31, 2010 - 2012. The notice increased Khonkhor's taxable income substantially and included a 75% fraud penalty in all three years and a delinquency penalty in 2010 for failure to file a return on time.

In total over the three years of the second notice, the IRS disallowed $476,154 in claimed business expenses "because it was determined that they were personal expenses and not deductible," $30,341 in net operating loss deductions because the loss "was attributable solely to nonbusiness expenses," $122,019 in unreported income from offshore accounts, and $511,984 of what Khonkhor called loans that the IRS believed were "actually unreported income."

Finally, the IRS disallowed a 2011 Khonkhor expense deduction for $338,871 titled "The MMA Lab, LLC -€” net loss" with the agency noting, "...we have not received any information to support what this deduction is for."

While unconfirmed, it appears from a variety of corporate filings that Gracie, via Khonkhor Enterprises, may have been an early owner of The MMA Lab, the Arizona gym that would eventually become known as the home of one-time UFC lightweight champion Ben Henderson and his trainer John Crouch.

Crouch has a connection to Royce Gracie, having earned his jiu-jitsu black belt under the UFC legend and serving time as a Gracie Academy certified instructor. In a 2014 interview for UFC.com, Crouch revealed that in 2006 his friend and former Gracie Academy training partner, Jason Beck, wanted to open an MMA gym in central Arizona.

It is unclear if Crouch had any initial ownership in the gym. Corporate records show that The MMA Lab, LLC was incorporated on Nov. 16, 2006 with two members having a 20% or greater interest in the company -€” JBeck Investments and Khonkhor Enterprises.

Gift - Gracie-IRS - 2a - The MMA Lab - Khonkhor Member 1

Gift - Gracie-IRS - 2a - The MMA Lab - Khonkhor Member 2

Future UFC champion "Smooth" Ben Henderson would soon join the fight team and in early 2012, Damon Martin wrote at MMA Weekly that Henderson purchased The MMA Lab "just a few weeks before..." UFC 144 (held on Feb. 26). According to corporate records, it appears ownership was actually transferred to three main players.

AZ Muay Thai, LLC is a company originally started by Joe Ervin which happened to amend its articles of organization on Jan. 25, 2012 to list three members with a 20% stake or greater: MJE, LLC (Ervin), Smooth Fitness, LLC (Henderson), and JCBJJ, LLC (Crouch).

Not long after on Mar. 1, Beck and Khonkhor changed the name of their company from The MMA Lab, LLC to MML2012, LLC. Eight days later on Mar. 9, AZ Muay Thai officially registered the trade name "The MMA Lab."

So it certainly appears that the Gracies and Beck transferred their ownership interest in The MMA Lab to Henderson, Crouch, and Ervin sometime around early 2012, with the transaction possibly executed in late-2011 which would explain its appearance in Khonkhor's 2011 taxes.

If Khonkhor's claimed net loss deduction is accurate, Henderson and Crouch would've either paid into or possibly simply taken over a gym that had just lost one of its primary two owners over $300,000 in roughly five years of operation (including whatever portion of the purchase price Khonkhor received, if any).

While investing into a supposed money-bleeding gym might seem a little curious, we can be sure that if and when the IRS receives the supporting information it seeks, an agent will scour the details to verify the validity of Khonkhor's claimed deduction.

According to Bloody Elbow's tax expert, it is notable that the IRS explicitly stated it was disallowing the "expense deduction" for The MMA Lab, LLC. LLCs file their own tax returns relating to annual revenues and expenses, and any investment returns from owning an LLC should be classified as capital gains or losses. Given this apparent inconsistency and the size of the reported "expense deduction," it doesn't surprise our tax expert that the IRS disallowed the whole thing.

Overall, the IRS determined that the Gracies' Khonkhor Enterprises owes the U.S. government $477,455 in additional taxes, $300,525 in fraud penalties, a $15,351 negligence penalty, and an $18,942 delinquency penalty for a grand total of $812,273, according to both IRS deficiency notices.

Combined with the personal deficiency notice on which Bloody Elbow reported in January, the Gracies and Khonkhor as a whole are staring at a maximum potential tax liability of $1,962,222.25, according to court documents.

The Gracies and Khonkhor have filed petitions with the U.S. Tax Court challenging the IRS's findings of tax underpayment, accuracy-related negligence penalties, and fraud. In March, the petitions were consolidated into a single case and the scheduled June 6 trial date was continued to allow additional time to hold settlement discussions.

The new trial date is currently scheduled for Sept. 26 and, should settlement talks fail, the Gracies and the IRS are also discussing changing the trial's location from Philadelphia to Los Angeles "where the [Gracies] and witnesses reside." It is unknown at this time if Bloody Elbow's discovery and reporting of this case rendered the Gracies' original request for a Philadelphia trial location unnecessary.

If the case progresses to trial, the Gracies and Khonkhor, as petitioners, will bear the burden of proving that the IRS's deficiency notices are incorrect, with one exception. The IRS will bear the burden of proving fraud, and on the specific fraud claims the burden must "be carried by clear and convincing evidence."

What's clear and convincing thus far is that the IRS is extremely suspicious of the ways in which the Gracies' and Khonkhor's taxable incomes have been reported in the past. Bloody Elbow's reporting has dealt with their disputes with the IRS over federal taxes. If the agency's determinations are true, our tax expert believes California's Franchise Tax Board will also want its cut of the income-adjusted pie at the state level.

The author has personal experience dealing with both tax agencies and if one thinks of the IRS as Kimbo Slice, then consider California's Franchise Tax Board as Fabricio Werdum or Cain Velasquez -€” you don't want to mess with them, ever.

Bloody Elbow's tax expert for this story was Christopher Keleshyan of Strategic Tax Group. Follow him @ChrisKeleshyan. Paul is Bloody Elbow's analytics and business writer. Follow him @MMAanalytics.