The recent United States Supreme Court decision United States v. Fior D'Italia allows for the use of the aggregate estimation method to assess restaurant owner's Federal Income Contribution Act (FICA) taxes. FICA taxes are employment taxes used to fund the Social Security and Medicare programs. FICA taxes consist of two portions: (1) the employee portion, which is withheld by the employer for the employee and (2) the employer's portion, which is paid on behalf of the employee. The aggregate method allows the IRS to estimate a restaurant owner's FICA tax liability by multiplying the average tips left on credit cards by the restaurant's total receipts. The IRS favors the aggregate method because it decreases the tax gap and increases tax revenues. However, restaurant owners can be blindsided by unexpected tax liabilities under the aggregate method. The restaurant, Fior D'Italia, argued that the IRS lacked statutory authority to use this method. The restaurant contended that the IRS must first assess each individual employee to determine the employer's FICA tax liability. The aggregate method has serious flaws, such as inaccurate tax liability determination, lack of statutory authority, and impeding the purpose of FICA taxes. In light of the Fior D'Italia decision, a new solution is now needed. This article proposes that restaurant owners should be required to track employees' tips. This proposal will solve the problems associated with the aggregate method. In addition, the new solution will also provide several benefits, such as accurate and equitable tax liability determination and increased taxpayer compliance. Page 1267
They came in waves throughout the entire night. The onslaught began at seven o'clock and did not end until well after midnight. Being an incoming freshman at the local university, and not from the area, Wally could not fathom the multitude of fanatics who had been fraternizing festively all day before the big gameCall of whom now seemingly wanted a seat in his section at the Blackout Steakhouse. Despite his best efforts, he dumped a glass of water in a young lady's lap, served two tables the wrong entrees, and inadvertently double charged another table. Needless to say, Wally received no tip from these tables. He was "stiffed."
Blackout Steakhouse is an international corporation with restaurants predominantly located throughout the United States. The renowned restaurant chain employs over one thousand waiters, waitresses, and busboys. While not on the verge of bankruptcy, Blackout's bottom line has seen better times.
Situations similar to Wally's are typical. In fact, Blackout executives estimate that approximately thirty waiters or waitresses are stiffed each night in their restaurants. While, the practice of customers "stiffing" waitpersons is an occupational hazard throughout the food and beverage industry, Blackout is not concerned. The restaurant still receives payment for the bill. Granted, diminished employee morale and possible loss of customers are worthy concerns. These costs are purely speculative though. However, after a recent visit from an Internal Revenue Service agent armed with a new weapon provided by a recent Supreme Court decision, Blackout should evaluate this situation with a greater amount of concern than previously thought.
In United States v. Fior D'Italia, the Supreme Court recently held that the aggregate estimation method to determine a restaurant owner's Federal Income Contribution Act (FICA) liability is Page 1268 permissible.1 The FICA tax consists of two parts, the employee portion2 and the employer portion.3 The employee portion is withheld by the restaurant owner/employer from the employees' wages, while the employer portion is the amount due from the employer for his employee(s). Due to the nature of the restaurant industry, a significant portion of certain restaurant employees' pay, particularly waiters and busboys, is in the form of cash. Cash is inherently susceptible to under-reporting. The Internal Revenue Service (IRS) has attempted numerous times to control the problem of under-reporting. Consequently, many disputes have occurred between taxpayers and the IRS in this area. Page 1269
In one attempt to control under-reporting by restaurant employees and resulting under-payment of taxes by employers, the IRS developed the aggregation method, also known as the aggregate estimation method or the aggregate method.4 The aggregation method of determining an employer's FICA tax liability consists of multiplying the restaurant's total receipts by a percentage determined by calculating the average tip left on credit card sales. The aggregate method appeals to the IRS primarily because the method decreases the tax gap. The tax gap is the difference between the amount of taxes owed and the amount of taxes actually paid. By collecting revenues that otherwise would not be reported, the IRS decreases this gap.
However, the aggregate method is not without problems. Concerns with the aggregate method include potential for an inaccurate tax liability determination, lack of statutory authority, and application of the method in other industries. Conversely, the method advocated by taxpayers and, arguably, statutorily required involves the IRS determining the FICA taxes of each individual employee before assessing the employer's share.
After a split in the circuits5, the two alternatives squarely confronted the Supreme Court in Fior D'Italia with the aggregation method emerging victorious but not without serious defects. Because of pervasive negative ramifications in this decision, such as IRS over- reaching and over-stated employer FICA tax liability assessments, a more viable solution is needed. This note traces the history of the aggregation method, explores the problems inherent in the method, and proposes an alternative solution that would result in accurate determinations of FICA liability for restaurant owners. This article proposes a revision to I.R.C. ß 60016 and ß 60537 requiring restaurant owners to keep track of their employees' tips. Part II of this note discusses the historical evolution of the aggregate estimation method as it developed jurisprudentially. Part III analyzes the Court's majority and dissenting opinions and identifies the problems created by the aggregation method. Part IV proposes an alternative solution, requiring restaurant owners to keep track of their Page 1270 employees' tips, and details the advantages of using such a method relative to the aggregate method.
The aggregate method did not appear in the IRS's arsenal overnight. The origin of the method dates back over forty years with the finished product cumulating in Fior D'Italia. Over the forty years, the method morphed through the jurisprudence into its current state. Courtesy of the result in Fior D'Italia, the aggregate method is currently a formidable arrow in the IRS's quiver. To better understand the magnitude of Fior D'Italia, a historical examination is needed.
A split in the circuits necessitated the granting of the petition for certiorari by the Supreme Court in Fior D'Italia.8 By tracing the historical development of the aggregate estimation method, one can better understand the issues that confronted the court in Fior D'Italia and recognize that a new solution is now needed. The aggregate estimation method can be traced to the following decisions: (1) Mendelson v. Commissioner9 and Meneguzzo v. Commissioner;10 (2) McQuatters v. Commissioner;11 (3) Morrison Restaurants, Inc. v. United States;12 (4) Bubble Room, Inc. v. United States;13 (5) Page 1271
Quietwater Entertainment, Inc. v. United States;14 and (6) 330 West
Hubbard Restaurant Corp. v. United States. 15
The origin of the aggregate estimation method is rooted in jurisprudence. Two 1960s cases, Mendelson v. Commissioner16 and Meneguzzo v. Commissioner,17 provide the method's underpinnings.
In both cases, the court relied on section 446(b) of the Internal Revenue Code18 for authority to use an indirect method to estimate income. The court in Meneguzzo commented that in absence of taxpayer records the IRS A. . . is authorized by section 446 to compute income in accordance with such method as . . . does clearly reflect income."19 Mendelson and Meneguzzo both involved using an indirect method to estimate income of individuals.