Tax
Jun. 19, 2002
Fior d'Italia Loses Fight With IRS
SAN FRANCISCO - Nobody knows exactly how much money waiters pocket each year in tips, but the U.S. Supreme Court on Monday said the IRS has a good guess.
In a case brought by Fior d'Italia, a 116-year-old San Francisco institution that touts itself as "America's Oldest Italian Restaurant," a divided court approved the Internal Revenue Service's method for estimating tips and then taxing them.
The North Beach eatery reached the nation's high court seeking a refund of just $18.32. But the court's opinion will cost the restaurant industry much more. Lawyers say the opinion could result in $7 billion to $10 billion a year in new taxes.
The opinion may also affect other businesses with frequently tipped employees such as hotels, taxi services, beauty salons and casinos.
The opinion deals with the tricky subject of the Social Security tax, known as FICA, or the Federal Insurance Contribution Act tax, when applied to restaurants. Tips are considered wages paid by employers, and employers are required to pay a 7.65 percent FICA tax on those wages. But waiters rarely provide accurate reports of their tips.
The IRS claimed that Fior d'Italia underestimated its tax in 1991 and 1992. The IRS then used credit card receipts to deduce that customers tipped about 14 percent. They applied that rate to the restaurant's total receipts to estimate its FICA tax.
The restaurant filed a lawsuit, claiming that the government must calculate tax based on tips actually received by individual employees. They argued that the government's "aggregate assessment" method doesn't account for cheap cash tips, the occasional customer who stiffs a waiter by not tipping at all, or the practice of sharing tips with hosts and bartenders.
Writing for a 6-3 majority, United States v. Fior d'Italia, 2002 DJDAR 6699, Justice Steven Breyer approved the IRS practice. The decision reverses an opinion from the 9th U.S. Circuit Court of Appeals written by Judge Alex Kozinski.
In a dissenting opinion, Justice David Souter wrote that the IRS practice unfairly saddles restaurant owners with a greater liability that Congress didn't intend. He was joined by Justices Antonin Scalia and Clarence Thomas.
Assistant U.S. Solicitor General Eileen J. O'Connor, who argued the case, said the opinion doesn't represent a radical change for restaurants because most already have the data they need to accurately calculate waiters' tips.
"The opinion confirms that the IRS has the authority to make a reasonable estimate, and a taxpayer who thinks an assessment isn't reasonable has the ability to challenge it," she said.
Tracy J. Power, a partner at Power & Power in Arlington, Va., who represented Fior d'Italia, called the opinion a "devastating blow" to the restaurant industry. The opinion allows restaurant owners to challenge any IRS assessments they deem unreasonable, and she encouraged restaurateurs to do so.
"The IRS shows over and over again that their estimates are overstated," she said. "I sure would fight them. I think employers have to give careful thought how to protect themselves from the capricious whim of IRS agents as they implement this new, judicially-created authority."
Powers said the fight will now switch to Capitol Hill, where various groups are lobbying to have the law changed.
Also, some restaurants have filed lawsuits questioning the statute of limitations on the tax. While the IRS has argued that it can apply the formula retroactively to 1988, the year the tax law was adopted, others have tried to limit it. The question is pending in several courts across the country, Power said, including one case pending before the 2nd U.S. Circuit Court of Appeals in New York.
Tyler Cunningham
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