Monkichi Ito v. Commisioner, TC Summ. Op. 2008-38 (April 16, 2008)
Mark Monkichi Ito worked as a bar tender in the lobby lounge at the Grand America Hotel, an opulent establishment in Salt Lake City. As luck would have it, the IRS conducted both an employment tax audit of the hotel and an income tax audit of Mark. To determine the accuracy of the tip income being reported, the IRS used the tip income documented credit card sales at the food and beverage locations in the Grand America Hotel, applying a discount to those amounts to calculate tips received on cash sales. That information was then used to calculate an employee per hour tip rate. Taking into consideration the number of hours Mark worked, the IRS determined that Mark had received tips well in excess of what he reported on his return, and therefore proposed a deficiency.
Mark did not keep appropriate records of his tip income, and conceded that the amount of tips received was in excess of that reported on his return. He objected to the figure arrived at by the IRS, however, on the basis that bartenders in the lobby lounge routinely received substantially less in tips than the wait staff in the restaurant. In support of this contention, Mark pointed out that his hourly wage was set at an amount that was more than four times higher than members of the wait staff, ostensibly to make up for the anticipated difference in tips.
Tip income received by a taxpayer constitutes compensation for services rendered and is includable in the taxpayer’s gross income. Catalano v. Commissioner, 81 T.C. 8, 13 (1983), aff’d. without published opinion sub nom. Knoll v. Commissioner, 735 F.2d 1370 (9th Cir. 1984); Way v. Commissioner, T.C. Memo. 1990-590. Consequently, tip income is described in Enrolled Agent review as equivalent to wages. In order to establish the amount of tip income, the taxpayer is required to maintain appropriate records reflecting the tips received. Treas. Reg. § 1.6001-1(a). If he or she fails to do so, the IRS may use any reasonable method to reconstruct the taxpayer’s income. United States v. Fior D’Italia, Inc., 536 U.S. 238, 243 (2002); Mendelson v. Commissioner, 305 F.2d 519, 521-522 (7th Cir. 1962), aff’g. T.C. Memo. 1961-319. Some Enrolled Agent jobs entail delivering this warning to taxpayers.
A common technique used by the IRS and studied in Enrolled Agent training is to estimate the aggregate tips received by all employees is determining the total amount of tips reported on credit card transactions and extrapolating that amount to the combined credit card and cash sales, using a discount to reflect the fact that the tip rate on cash sales is likely to be less than that on credit card sales. Once the aggregate amount is determined, each individual employee’s pro rata share is calculated based on the relative number of hours worked. This technique was first approved by the Tax Court in McQuatters v. Commissioner, T.C. Memo. 1973-240.
Mark’s argument makes logical sense. It seems reasonable to assume that dinner bills will generally be well in excess of bar tabs and that the servers in the restaurant would therefore receive larger tips. Likewise, it seems probable that this situation was a principal reason that the hotel paid higher hourly wages to the bar staff.
Logic and reason, however, are but little use to a taxpayer in Tax Court when there is a failure of proof, which is a fact Enrolled Agent courses are quick to reveal. As pointed out above, the law required Mark to maintain contemporaneous records of his tips. He did not do so. Furthermore, at the trial he called no witnesses and offered no documentation to corroborate his arguments. The court noted that this would not have been hard to do. Surely he could have presented a comparison of bar credit card charges to restaurant credit card charges or other financial records demonstrating the difference in sales. These are tasks easily performed for Mark by a tax professional with Enrolled Agent education. Mark could have offered testimony of management as to why they differentiated the hourly wages. He did none of this.
In all trials before the Tax Court the burden of proof is on the taxpayer. Tax Ct. R. 142(a). Furthermore, the determination of tax liability by the IRS is presumptively correct, and the taxpayer must prove by a preponderance of the evidence that the IRS’s determination is improper. Welch v. Helvering, 290 U.S. 111, 115 (1933); Tax Ct. R. 142(a).
Given that Mark offered virtually no evidence, the court had little choice but to sustain the IRS’s determination. Not only that, the court upheld the imposition of an accuracy-related penalty due to negligence or disregard of rules or regulations under Code Section 6662(b)(1) because Mark failed to keep records and to made no reasonable attempt accurately to report his tip income.
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