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Tax those tips

Law Review Jim Porter

Restaurant owners beware. The IRS is about to mess with your livelihood.

Remember the days when waiters, waitresses and bus people kind of “forgot” to report all of their tips to IRS? I know, because like most of you, I was a waiter – putting myself through college.

Of course, in those days, a good tip night was $10 or $15, not much to report. Actually, the other waiters made huge tips. Maybe I was serving bad food.

Well, those days are over. My wait days and low tip reporting.

Fior d’Italia, a San Francisco institution that bills itself as “America’s Oldest Italian Restaurant,” challenged the IRS’s method of estimating tips. The North Beach eatery was paying FICA taxes on its waiters’ tips, which are considered wages, based upon the waiters’ reports of their tips. The standard practice.

The IRS took the position that waiters under-report their tips. Duh! The Service used the “aggregate estimation” method of calculating tips, which is to use credit card receipts to deduce what customers tip, 14 percent in Fior d’Italia’s case, and then applied that percentage to the restaurant’s total receipts – to estimate its FICA taxes.

The IRS came after Fior d’Italia claiming it owed in excess of $22,000 for unpaid taxes. The restaurant sued, claiming the government should calculate the tax based upon the tips actually received by employees. For example, cash tippers tip less than credit card users and sometimes even stiff waiters (who really stiffs a waiter?), plus waiters often share tips with bartenders and bus people, thus reducing their taxable tips.

As Fior d’Italia argued, the government’s use of the “aggregate estimate” approach, generalizing tax receipts based on credit card tip receipts, rather than actual employee tip information, forces the employer into policing and actually counting employees’ tips, i.e., the employer is being punished for the employee’s potential “cheating” the government by understating tips. The U.S. Supreme Court was willing to impose that burden on restaurants. Fior d’Italia lost.

The potential loss to restaurants and waiters and waitresses is huge. The Supreme Court opinion may also affect other tipping businesses, like hotels, casinos and taxi drivers.

The Court discounted Fior d’Italia’s argument that its taxing scheme allowed for “abuse of power,” with the offhand statement that “an abuse of power possibility exists in respect to many discretionary enforcement powers.” What, IRS abuse its power?

Look for legislation to return to the time-honored tip practice. Indeed, the Court closed its opinion with this sentence: “In saying this, we recognize that Fior d’Italia remains free to make its policy-related arguments to Congress.”

Jim Porter is an attorney with Porter Simon, with offices in Truckee, South Lake Tahoe and Reno.


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