Bartender's Meticulous Records Defeat IRS's Claim of Unreported Tip Income.

(Parker Tax Publishing March 19, 2015)

The Tax Court held that a Las Vegas bartender, audited after he stopped participating in an IRS tip compliance program, had fully reported his tip income. The court concluded that the taxpayer's records reflected his income earned from tips more accurately than the IRS's reconstruction formula did. Sabolic v. Comm'r, T.C. Memo. 2015-32.

Background

Alan Sabolic, a bartender with over 20 years of experience, worked at the Zuri Lounge at the MGM Grand Hotel and Casino (MGM Grand). During 2009 to 2011, Sabolic chose not to participate in the IRS's Gaming Industry Tip Compliance Agreement Program (GITCA Program). GITCA sets an automatic tip rate for participating employees used to calculate taxable tip income. Sabolic had participated in the GITCA Program for over 20 years, but opted out of the program citing concerns that the automatic tip rate was too high and did not reflect the poor economic conditions.

Since Sabolic opted out of the program, he was required to self-report his cash tips to MGM Grand and keep personal records of how much he received in tips. At the end of each shift, he would add together his tips and enter the total into the MGM Grand's system, tip-out the barbacks, and give the cashiers the loose change he would receive with cash tips. He also kept a daily personal tip log, recording the total on a slip of paper. Sabolic reported income from tips of $18,110, $23,941, and $21,926 for tax years 2009 to 2011, respectively, and also claimed deductions for the tip outs.

The IRS contended Sabolic's logs were inadequate and determined deficiencies for 2009 to 2011. In calculating the amount owed, the IRS reconstructed Sabolic's tips based on sales records, reduced by 10 percent to account for the tip outs to the barbacks. The IRS determined that Sabolic had underreported his tip income by $19,729, $19,000, and $20,284 for 2009 to 2011.

Sabolic challenged that determination, arguing the IRS's reconstruction did not accurately reflect his tip income and petitioned the Tax Court.

Analysis

Tips constitute compensation for services and are includable in gross income (Reg. Sec. 1.61-2(a)(1)). When a taxpayer receives tips daily, he or she is required to keep an accurate and contemporaneous record of such income (Reg. Sec. 31.6053-4(a)(1)). When a taxpayer's records are inadequate or incomplete, the IRS can reconstruct the employee's tip income in any manner that clearly reflects income. The IRS has great latitude in choosing the method of reconstruction, and the method chosen need only be reasonable in light of all of the surrounding facts and circumstances (Schroeder v. Comm'r, 40 T.C. 30 (1963)).

The IRS asserted multiple arguments designed to establish that Sabolic's logs were inadequate.

First, the IRS pointed to the fact that the logs were recorded in whole numbers, arguing that Sabolic was not tipped in exact dollar amounts. The court did not believe this made the records inadequate, noting Sabolic's explanation that the whole numbers reflected the fact he gave change he received to cashiers.

Second, the IRS argued that the daily tip logs were inadequate because Sabolic did not keep track of how much he actually tipped out the barbacks at the end of each shift. The court found that, while ideally Sabolic should have kept track of the exact amounts he tipped the barbacks, his testimony that he always tipped them between 10 percent and 20 percent and the fact the IRS allowed Sabolic a 10 percent reduction for tip outs defeated the IRS's assertion.

Third, the IRS claimed the logs were inadequate because they appeared to be missing days. The court, however, found that vacations, flexible work days, and frequent system outages adequately explained why the records appeared to be incomplete.

Finally, the IRS contended that the logs were inadequate because they did not precisely match up with the information on Sabolic's Forms W-2. The court disagreed, reasoning that while the information did not precisely match, timing differences in the pay period and malfunctions in the MGM Grand System that tracked tips likely accounted for the discrepancies.

The court noted that while in general the IRS's method of reconstructing taxpayers' tip income was reasonable, there was no evidence of a discrepancy in Sabolic's records that would result in the unreported income reflected in the IRS's calculations. Thus, in this case, the IRS's method was not an accurate reflection of Sabolic's income.

Because the court concluded the IRS's method did not reflect Sabolic's income as accurately as Sabolic's own daily records, the court ruled Sabolic was in compliance with the requirements of Reg. Sec. 31.6053-4(a)(1) and found Sabolic fully reported his tip income on his 2009 to 2011 tax returns.

For a discussion of employee tip recordkeeping and reporting requirements, see Parker Tax ¶124,105. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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