Battle over employer FICA tax.

• Author: Appel, David W.

The controversy over the IRS'S ability to assess employer FICA tax on employee tips continues. The Service is adamant in its attempt to assess an employer (without also auditing each employee) to determine each employee's unreported tip income. In a recent case, Quietwater Entertainment, Inc., DC Fla (6/25/99), a district court once again decided in favor of an employer. If appealed, this decision would go to the Eleventh Circuit, which previously ruled in rawer of the IRS on the same issue.

Tips are considered part of an employee's wages for FICA tax purposes under Sec. 3121(q). Several courts have held that the Service does not have the authority under Sec. 3121(q) to assess an employer's share of FICA taxes on its employees' unreported tip income on an aggregate basis, without first determining the underreporting by the individual employees and crediting their wage history accounts. Employers must apply and collect both the employer portion and the employee portion of FICA taxes on employees' reported tip income. The employer collects FICA tax until the employee's combined wages and reported tips exceed the taxable wage base for that particular year; withholding for income tax purposes continues for the year, regardless of whether the Social Security wage base limits have been reached. The employer is not liable for its portion of the FICA taxes on tips an employee failed to report to the employer until notice is received by and demand for taxes are made to the employer by the IRS.

In Bubble Room, Inc., 159 F3d 553 (Fed. Cir. 1998), the Court of Appeals confirmed Congress's intent to impose an employer-only FICA tax on employees who do not accurately report their tips. The court concluded that Sec. 3121(q) expressly contemplates that an employer may be liable for its share of FICA taxes, even if the records supplied by its employees are missing, inaccurate or incomplete. In this case, the reported figures reflected a tip rate of 16.4% on charge receipts and only 1.4% on cash receipts. Under these circumstances, it was reasonable for the Service to determine that the employer's accounting method did not accurately reflect the amount of tips received by its employees. The court granted the IRS flexibility to base its assessments on formulas when it was evident the taxpayer understated wages received and when it was impossible or impractical to determine the exact amount of wages actually received. This left the Service with no choice; it...