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June 18, 2002
Supreme Court OKs Gratuity Estimation
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Supreme Court issued a decision Monday in United States v. Fior d'Italia, Inc., concluding an ongoing feud with the IRS over the taxation of tip income. The Court's decision ends 10 years of litigation and presents the landmark San Francisco restaurant Fior d'Italia with $23,000 in back taxes owed to the IRS.

Fior d'Italia owner Bob Larive says that this decision could mark the beginning of sweeping changes in how the IRS collects taxes on tip income in all tip-earning industries across the country. Types of workers affected include restaurant servers, hair stylists, hotel bellhops, taxi drivers and others.

Larive told the San Francisco Chronicle that the decision is "devastating to the industry. Basically, it gives the IRS carte blanche to come in and throw these bogus numbers at people and scam us out of taxes we don't owe." He and his lawyers speculate that some of the country's 200,000 restaurants may be forced out of business.

The case began in the early 1990s when the IRS began investigating Fior d'Italia due to the nearly $350,000 discrepancy in tips on credit card slips and tips claimed by the restaurant employees over a two-year period.

The IRS arrived at the figure of $23,000 in FICA taxes owed by the restaurant by multiplying the average tip on credit card receipts - about 14 percent - by the total receipts. Lawyers argue that this system does not accurately account for customers who leave no tip. The restaurant's lawyers further argued that the IRS should audit individual workers suspected of underreporting rather than auditing the employer.

Furthermore, Fior d'Italia employee Matthew Herman told the Chronicle that the IRS' system also neglects to take into account the so-called "social hierarchy" of tipping. "American Experess customers tip better than Visa or MasterCard customers, and they all tip better than cash customers," he said.

The California Court of Appeals in San Francisco upheld a refund lawsuit filed by Fior d'Italia, but the Supreme Court ruling issued yesterday overturned the ruling of the lower court. The restaurant argued that tips, defined as being "received by an employee in the course of his employment" prohibits the IRS from imposing tax liabilities upon the employer.

In response, Justice Stephen Breyer wrote in his majority ruling: "In our view Fior d'Italia's linguistic argument makes too much out of too little. We simply do not see how this kind of language, taken as a whole, argues against use of an aggregate estimation method that seeks to determine the restaurant's total FICA liability."

Justice David Souter dissented, arguing that the additional Social Security taxes paid by the employer would be offset by a 1993 social security tax credit. He further stated that he foresees no overall benefit to the government as a result of auditing employers. Justice Souter also noted that California law prohibits the IRS from using coercion to gain taxpayer participation and that Congress never intended for employers to be saddled with the burden of monitoring their tip-earning employees.

Monitoring taxation of self-reported tip income, which was reportedly $14.3 billion in 1999, has always been a problem for the IRS, according to IRS spokesman Chips Mauer. "The Supreme Court's important decision upholds our ability to make sure all Americans pay their fair share of taxes," Mauer said. "The goal is to create a fair and accurate system of reporting tax income, while minimizing the burden on taxpayers."

Despite the ruling, the issue may not be tabled for good. Justices Breyer and Souter both insinuated that the issue should be brought before Congress. Fior d'Italia owner Larive added that he intends to push for new legislation.

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