- The Washington Times - Tuesday, June 18, 2002

The Supreme Court ruled yesterday that the Internal Revenue Service can use estimates to make sure it is collecting enough taxes on cash tips, a decision expected to affect about 200,000 restaurants and other businesses.

The 6-3 ruling allows the IRS to continue collecting taxes from employers on cash tips based on those shown on credit card receipts.

The IRS uses a system to estimate all tips using credit card receipts and assuming that cash ones averaged the same amount. Restaurant owners say the average 14 percent is not fair.

"This could have a huge negative impact on the economy if the IRS now sends out tax bills to restaurants that have tipped employees," said Peter Kilgore, general counsel and senior vice president of operations of the National Restaurant Association.

"Seven out of 10 restaurants are small businesses, many of which operate with slim margins," he said. "Quite frankly, this decision could mean the difference between a restaurant staying in business or closing its doors."

San Francisco's Fior d'Italia, which opened in 1886 and is one of the nation's oldest Italian restaurants, challenged the IRS' system, contending it does not take into account lower cash tips, take-out meals and tip-sharing.

The 9th Circuit Court of Appeals, based in San Francisco, ruling in favor of Fior d'Italia, said the IRS could not use the estimates if the IRS could not prove that people who paid in cash tipped an average of 14 percent.

The Supreme Court reversed that decision yesterday, saying the methods used by the IRS are not unreasonable and that employers have the right to challenge their individual tax assessments.

Although the ruling affects only the business owners, employees who receive tips are subject to individual audits by the IRS and can be held accountable for not reporting all of their tips.

Employees nationwide reported $14.3 billion in tips in 1999, but the IRS says the number could be higher. Because employers are required to pay 7.65 percent in Social Security on employees' tips, the ruling could mean employers would have to pay more if the IRS determines tips were underreported by employees.

"We are deeply disappointed by the Supreme Court's decision, which basically condones the IRS' unfair and unjust tactics to pit restaurateurs against their own employees, turning them into 'tip police,'" Mr. Kilgore said.

Michael Sternberg, co-founder and chief executive of Sam & Harry's Restaurant Group, said the ruling won't help the restaurant owners' relationships with their employees.

"Now more than ever, I've got to try to really police my employees," said Mr. Sternberg, who is also a board member of the National Restaurant Association. "We're not working together; we're working against each other."

The IRS defended the ruling.

"The court's important decision upholds our ability to make sure all Americans pay a fair share of taxes," said IRS Commissioner Charles O. Rossotti.

Mr. Sternberg, whose company owns the Sam & Harry's restaurants in Dupont Circle and Vienna, and the Caucus Room on Ninth Street NW, says the ruling makes restaurant owners responsible for their employees' decisions.

"The declaration of tips is solely the employee's responsibility and should not be the restaurant owner's responsibility," he said. "Why hold the employer responsible for that?"

Bob Larive, owner of Fior d'Italia, said he hopes the ruling doesn't translate into more audits of restaurants.

"Hopefully, this won't open up a Pandora's box of audits, whereby the IRS can come in and decide what they think the proper number is for tips, and therefore, assess FICA taxes on some random number they have invented," he said.

In a dissenting opinion, Justice David H. Souter said the court's decision "saddles employers with a burden unintended by Congress."

Also dissenting were Justices Antonin Scalia and Clarence Thomas.

Mr. Larive said they he and other restaurant owners will work on getting Congress to clarify the IRS statutes.

"Now we will probably have to go to Congress for clarification of their original intent and for relief from the IRS' draconian methods," he said.

Mr. Kilgore said the fight isn't over.

"We will most certainly be making our case on Capitol Hill," he said.


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