Supreme Court to Settle Tip Taxation Controversy

The U.S. Supreme Court heard arguments Monday in a case that could change the way the Internal Revenue Service assesses Social Security taxes on tip income. This far-reaching case could affect restaurants, casinos, barber and beauty shops, hotels, and any other businesses where employees regularly receive tips from customers.

The case, United States v. Fior d'Italia, involves a San Francisco restauranteur who claims that the IRS is incorrect in assessing the restaurant's share of Social Security taxes on employee tip income based on estimates made from tips recorded on credit card charge slips. The 9th U.S. Circuit Court of Appeals has sided with the restaurant, explaining that making blanket estimates of all tips based on information on credit card slips incorrectly assumes that cash tippers tip as much as credit card tippers. "People paying in cash, however generous they may feel, are limited by the amount of cash in their wallets," opined the court.

Furthermore, according to the legal brief filed with the U.S. Supreme Court by Fior d'Italia, the only way to accurately know how much employees receive in tips is to rely on reporting by the employees. "Since tips are…split with indirectly tipped employees (e.g. hostess, busboys, bartenders, bread girls, etc.) in varying amounts at the discretion of the directly tipped employees, employee reporting is the only way for an employer to know the amount of tips retained by individual employees."

The restaurant's attorney, Tracy J. Power, points out that waiters, waitresses, and bartenders don't even earn the amount of tips shown on credit card receipts. The workers share tips with other employees, some of whom are exempt from taxation on the small amount of tips they earn.

Reports are that the Supreme Court justices seemed sympathetic with the restaurant when responding to oral arguments on Monday, however Justice David Souter reminded spectators that although "it makes a lot of sense" to criticize a law in which "the burden is on the taxpayer to give information he is not in the best position to know," the IRS might still prevail because there is no high court precedent that requires common sense to be a requirement when it comes to tax laws.

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