Friday, October 23, 1998

IRS wins a round in battle over taxing restaurant tips

By CURT ANDERSON

Associated Press

WASHINGTON -- Uncle Sam doesn't serve the food or the wine, but the government is insisting on its share of the tip.

The Internal Revenue Service has won another round in its long court battle to force restaurants to cough up payroll taxes on tips, even if they're not reported to employers as required by waiters, waitresses, bussers and bartenders.

Although the IRS insists its new focus is a voluntary program based on educating restaurant employees, the recent U.S. Court of Appeals decision marks the second time a federal appellate court has certified the government's authority over tips.

The National Restaurant Association promised Thursday to continue the fight, both in court and in Congress, to shift the IRS tax burden to the employees.

"They shouldn't be able to go after the employers for something that is clearly the employees' responsibility," said Kathleen O'Leary, lobbyist for the 175,000-restaurant organization.

At stake are billions of dollars in cash tips plunked down on tables at eateries and taverns that do $250 billion in business each year. No one is sure how much people dole out in cash tips, because unlike credit card transactions, few records are kept.

In 1996, the most recent year complete records are available, $6.2 billion in tips were reported to the IRS from food and beverage establishments -- an amount the agency believes is less than a third the real amount.

Employees are supposed to report all tip income to their employers each month so that both can contribute their proper shares of payroll taxes into the Social Security fund.

"The tipped employees are, in effect, bound by an honor system," observed a three-judge panel of the U.S. Court of Appeals for the Federal Circuit in its decision last week.

When the employees fail to keep their end of the bargain, however, the judges said the law still makes employers liable for payroll taxes. The panel upheld the IRS's power to use a formula to estimate what the business should owe, without trying to track down the employees first.

"Congress specifically contemplated the assessment of an employer-only (payroll) tax when employees do not accurately report their tips," the judges wrote.

The ruling came in a case brought by the Bubble Room, which operates locations in Captiva and Maitland, Fla. The Bubble Room's owners were assessed $37,269 in taxes and interest by the IRS in 1990 after reporting a cash tip rate of only 1.4 percent, compared to 16.4 percent on credit card tips.

Because IRS did not audit the employees and relied on its formula, restaurant officials say the court's affirmation could bring an unwanted burden to thousands of businesses.

"We believe Congress never meant to give the IRS a way to force restaurant owners to become the tip police," said Herman Cain, chief of the National Restaurant Association.

The issue is far from settled. Three lower federal courts -- including one in California this week -- have sided with the restaurants. The IRS has now won twice on appeal.

The IRS says its goal in court is to prevent erosion of its authority to do employer-only payroll tax assessments, even as it emphasizes a program in which employers agree to provide training and a better system for accurate tip reporting.

"This smoothes out the whole process," said Tom Burger, director of the IRS employment tax compliance office. "It is much more conducive to ensuring compliance than doing a one-on-one audit."

Still, National Restaurant Association attorney Peter Kilgore pointed out, "If the IRS wants to play hardball, they can" under the court's ruling.