Because restaurants deal in cash and tips, the Internal Revenue Service (IRS) has devised systems to enforce tax compliance by requiring employers bear the ultimate burden for Federal Insurance Contribution Act (FICA) taxes owed by employees under reporting the tips they receive. It does this by requiring restaurant to file an Employer’s Annual Information Return of Tip Income and Allocated Tips, IRS form 8027. This IRS form summarizes the total sales, charged sales, charged tips and total reported tips.
Form 8027 is designed to flag the amount of tips likely to have been made to the employees of the restaurant. If the amount of tip income reported by the employees is less than 8% of the restaurant’s total charged receipts, the employer is then required to allocate tip income to the employees. (United States v. Fior D’Italia, 536 U.S. 238) Coincidentally, when the Supreme Court decided this case, our very own founding partner, Stephen M. Moskowitz, was prominently featured in the San Francisco Bay Area providing legal commentary and analysis to various news outlets.
8% Threshold Is an Audit Trigger, but not the only Trigger for IRS to Audit
Generally, an IRS audit will be triggered when the Form 8027 falls below the 8% level. However, the law requires 100% reporting and the 8% threshold is only one way that the IRS monitors compliance and flags under reporting restaurants. For instance the IRS has full time agents specifically assigned as IRS Tip Income Specialists.
We recently had a case where despite the tips on the form 8027 information return being above 8%, the IRS had a Tip Income Specialist audit the restaurant to ensure 100% reporting. The IRS then assessed a liability based on this agent’s findings. Upon being retained, our tax law firm was able to utilize the Point of Sale (POS) system that tracked server sales by employee and we were able to demonstrate that the employees were reporting 100% of each server’s total credit card sales and total charged tips on credit cards. We then used this information and calculated a percentage to apply to the server’s cash sales. This method ultimately reduced the IRS’s assessment by 20%. Furthermore, we were able to limit the scope of additional allocations that the IRS may have otherwise opened and no penalties were assessed.
Further, we believe that the IRS routinely targets restaurants to both verify tax compliance, and to send a message to the restaurant industry. We further expect to see a trend in restaurant audits of this type because it is likely easier for the IRS to collect the tax from an ongoing restaurant versus tracking down servers who they deem to be un-reporting their income. Therefore, if you own a restaurant, please do not hesitate to contact us for assistance on how to reduce the exposure to your restaurant. Moskowitz LLP is a tax law firm bringing to your defense unwavering dedication, tax knowledge, and experience. We provide realistic and practical solutions. Contact us by phone or our contact form and receive a personal and timely response from our founding partner, Steve Moskowitz, Attorney at Law.
Moskowitz LLP, A Tax Law Firm, Disclaimer: Because of the generality of this blog post, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. Prior results do not guarantee a similar outcome. Furthermore, in accordance with Treasury Regulation Circular 230, we inform you that any tax advice contained in this communication was not intended or written to be used, and cannot be used, for the purposes of (i) avoiding tax related penalties under the Internal Revenue Code, or (ii.) promoting, marketing, or recommending to another party any tax related matter addressed herein.