Court could tip the scales on tips

WASHINGTON, April 22 (UPI) -- In a case that will be closely watched by restaurant, hotel and beauty salon operators all over the United States, the Supreme Court heard argument Monday on how Social Security taxes should be calculated for tips during audits.

The numbers aren't small. The latest figures show more than $14 billion in tips reported to the government each year.

The case involves the self-described "America's oldest Italian restaurant," San Francisco's Ristorante Fior D'Italia.

At issue is whether the Federal Insurance Contribution Act, or FICA, tax on employee tip income must be determined by looking at the totals of individual audits -- for example, separate audits of every waiter or waitress in an establishment -- or may instead be based on a "reasonable estimate of the aggregate amount of tips received by all employees."

FICA treats tips in excess of $20 a month as wages. Both the employee and employer are required to pay FICA taxes on them.

Usually, employees such as waitresses make monthly reports to their employers on the tips they receive so that FICA contributions can be calculated.

Restaurants with 10 or more employees are required to make annual reports to the Internal Revenue Service of the tips reported by employees.

Fior D'Italia filed forms showing that employees reported tips to supervisors of $247,181 for 1991 and $220,845 for 1992.

However, the forms also showed that the total amount of tips reported on customer credit card receipts alone at the restaurant far exceeded both those figures -- $364,796 in 1991 and $338,161 in 1992.

Nevertheless, the restaurant calculated its share of the FICA tax on the lower figures.

At that point, IRS officials pounced, conducting a compliance check of the restaurant.

Looking at the credit slip information, the IRS estimated that there was a 14.49 percent tip rate for 1991 and a 14.29 percent tip rate for the following year.

Multiplying those tip rates by the restaurant's gross receipts for those two years, and then subtracting the total tips actually reported on the restaurant's forms, the IRS determined that unreported tip income was more than $156,000 in 1991 and more than $147,000 in 1992.

That means you owe us $11,976 for 1991 and $11,286 for 1992 in employer's FICA taxes, the IRS told the restaurant. Pay up.

Not intimidated, the restaurant paid only a portion of the tax, then filed suit against the IRS.

In the suit, Fior D'Italia didn't dispute the IRS calculations; it just contended that the IRS lacked the authority to assess taxes on employers by using an aggregate estimate of tip income.

Under the law the IRS must first conduct individual audits of employees, then base any assessment of employer FICA taxes on the total indicated by the separate audits, the restaurant argued.

A federal judge agreed. A federal appeals court panel, by a vote of 2-1, agreed with the judge. The IRS, acting through the Justice Department, then asked the Supreme Court for review.

The appeals court "did not point to any language in the Internal Revenue Code as support for its conclusion, and there is none," the department said in a brief to the high court. Citing the dissenting judge's opinion on the panel, the department said the appeals court decision "invites employers and employees alike to evade their statutory tax obligations."

The Justice Department said it isn't talking about small change.

Since the IRS began its FICA enforcement program in response to a 1984 study, reported tips from the restaurant industry "increased from $8.52 billion in 1994 to $9.45 billion in 1995, to $10.19 billion in 1996, to $11.14 billion in 1996, to $12.17 billion in 1998 and to $14.31 billion in 1999."

Speaking for the IRS Monday, Assistant Attorney General Eileen O'Connor told the justices that three-quarters of the tax assessment on the restaurant was based on actual figures, with the rest estimated.

"Clearly, this assessment has a foundation," she said.

Speaking for Fior D'Italia, Washington attorney Tracy Power said the way the IRS attempts to assess the tax was not authorized by Congress.

She attempted to characterize the case with an analogy under which the owner of chickens is taxed for his neighbors' cows, with the government estimating the number of cows by the acreage in the neighbor's farm.

However, several members of the court, including Justices Ruth Bader Ginsburg and Stephen Breyer, said they found the analogy baffling.

Power then tried another tack. Employees have a whole range of information about their tip receipts to defend themselves against an individual audit, she told the justices.

Employers have no real individual information on receipts of tips, and have not been legally required to collect such information, she said.

"We simply have do not have the information to dispute that (assessment)," she said. " ... Congress for 30 years has told us we do not have to have that information."

A decision in the case should come before the Supreme Court recesses in late June or early July.

(No. 01-463, USA vs. Fior D'Italia)