Bubble Room, Inc. v. U.S.

• Decision Date: 16 October 1998
• Docket Number: No. 97-5030,97-5030
• Citation: 159 F.3d 553
• Parties: -6720, 98-2 USTC P 50,799, Unempl.Ins.Rep. (CCH) P 16081B The BUBBLE ROOM, INC., Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.
• Court: U.S. Court of Appeals — Federal Circuit

Page 553

159 F.3d 553

82 A.F.T.R.2d 98-6720, 98-2 USTC P 50,799,

Unempl.Ins.Rep. (CCH) P 16081B

The BUBBLE ROOM, INC., Plaintiff-Appellee, v. The UNITED STATES, Defendant-Appellant.

No. 97-5030.

United States Court of Appeals Federal Circuit.

Oct. 16, 1998.

Rehearing Denied; Suggestion for Rehearing In Banc

Declined Jan. 14, 1999.

James L. Malone, III, McDermott, Will & Emery, Chicago, IL, argued, for plaintiff-appellee. With him on the brief was Adam J. Narot. Of counsel on the brief was Peter Kilgore, General Counsel, National Restaurant Association, Washington, DC.

Bruce R. Ellisen, Attorney, Appellate Section, Tax Division, Department of Justice, Washington, DC, argued, for defendant-appellant. With him on the brief were Loretta C. Argrett, Assistant Attorney General, and Andrea R. Tebbets, Attorney.

Before PLAGER, SCHALL, and BRYSON, Circuit Judges.

Opinion for the court filed by Circuit Judge SCHALL. Dissenting opinion filed by Circuit Judge PLAGER.

SCHALL, Circuit Judge.

This litigation arises out of a tax dispute between a restaurant owner, the Bubble Room, Inc. (the "Bubble Room"), and the Internal Revenue Service ("IRS"). The principal issue presented is whether the IRS has authority under the Internal Revenue Code ("I.R.C." or "Code") to assess the Bubble Room's share of Federal Insurance Contribution Act ("FICA") taxes on unreported tips of its restaurant employees on an aggregate basis, without first determining the underreporting by the individual employees and then crediting their Social Security wage earnings records. The Court of Federal Claims granted summary judgment in favor of the Bubble Room, holding that the assessment of its share of FICA taxes on unreported tips in the aggregate was invalid under the Code because the taxes did not correlate with FICA tax paid by or assessed against individual employees. See Bubble Room, Inc. v. United States, 36 Fed. Cl. 659, 679 (1996). For the reasons set forth below, we vacate the resulting judgment in favor of the Bubble Room and remand the case for further proceedings.

BACKGROUND

I.

Some background relating to the tax scheme at issue may help the reader to better understand this case. The Social Security system has been described as "a form of social insurance" whereby "persons gainfully employed, and those who employ them, are taxed to permit the payment of benefits to the retired and disabled, and their dependents." Flemming v. Nestor, 363 U.S. 603, 609, 80 S.Ct. 1367, 4 L.Ed.2d 1435 (1960). The purpose of the Social Security Act, stated in its broadest terms, is to provide for the general welfare. See Helvering v. Davis, 301 U.S. 619, 640, 57 S.Ct. 904, 81 L.Ed. 1307 (1937). To that end, the Act covers a wide range of programs, including retirement (old-age) insurance, survivor's insurance, disability insurance, hospital and medical insurance for the aged and disabled, supplemental security income, and a variety of other public assistance services. See 42 U.S.C. § 301 (1988) ¹ (to "furnish financial assistance to aged needy individuals" and their survivors); 42 U.S.C. § 1351 (to "furnish financial assistance ... to needy individuals eighteen years of age and older who are permanently and

                totally disabled");  42 U.S.C. § 1381 ("to provide supplemental security income to individuals who have attained age 65 or are blind or disabled");  42 U.S.C. §§ 1395i to 1395i-2a (to provide hospital insurance benefits to aged and disabled individuals);  42 U.S.C. § 1395j ("to provide medical insurance benefits ... for aged and disabled individuals").  These programs are largely financed out of taxes paid by employers and employees under the provisions of FICA. 2  See 42 U.S.C. § 911.  FICA tax proceeds are paid into the United States Treasury, and each year an amount equal to the proceeds is appropriated to the Federal Old-Age and Survivors Insurance Trust Fund, the Federal Disability Insurance Trust Fund, the Federal Hospital Insurance Trust Fund, and the Federal Supplementary Medical Insurance Trust Fund, from which benefits and expenses of the Social Security System are paid.  See 42 U.S.C. § 911;  see also Flemming, 363 U.S. at 609, 80 S.Ct. 1367
                

A. Employee and Employer FICA Taxes

I.R.C. § 3101 establishes the employee's FICA tax obligation. ³ Under I.R.C. § 3101, every employee is required to pay a FICA tax, which is calculated as a percentage of his or her "wages" earned during the tax year. "Wages" are defined to include, with certain exceptions, "all remuneration for employment." I.R.C. § 3121(a). The employer is responsible for collecting the employee FICA tax from each of its employees "by deducting the amount of tax from the wages as and when paid." I.R.C. § 3102(a)-(b); see also 26 C.F.R. § 31.3102-1 (1989). ⁴

The obligation to pay FICA tax is imposed on employers independently of their employees' obligation. Compare I.R.C. § 3101 (establishing employee FICA tax) with I.R.C. § 3111 (establishing employer FICA tax). I.R.C. § 3111 imposes a FICA tax on every employer "having individuals in his employ." The employer FICA tax is computed as a percentage of "the wages ... paid by [the employer] with respect to employment." ⁵ Id. The employer tax attaches "at the time that the wages are paid by the employer." 26 C.F.R. § 31.3111-3.

B. Treatment of Tipped Income

With some exceptions, tips received by employees are treated as wages for both the employee and employer's share of FICA taxes. See I.R.C. § 3121(q) ("[T]ips received by an employee in the course of his employment shall be considered remuneration for such employment (and deemed to have been paid by the employer for purposes of subsections (a) and (b) of section 3111)."). There are two exceptions to this general rule. First, I.R.C. § 3121(a)(1) provides that the term "wages" does not include any "remuneration" received by an individual employee in excess of "the contribution and benefit base," which was $48,000 in 1989. Second, under I.R.C. § 3121(a)(12)(B), the term "wages" does not include cash tips received by "an employee" in any calendar month in which such tips are less than $20. The parties refer to the two exceptions collectively as defining a "wages band." Thus, as far as both employer and employee FICA tax liability are concerned, tips received by an individual employee are treated as "wages" only if the employee received at least $20 of tips in a particular month (the low end of the "wages band") and the employee has not already received tips and other remuneration during the year in excess of the annual wage limitation (the high end of the "wages band").

Tipped employees must "report all ... tips [received in the course of employment] in one or more written statements furnished to [their] employer on or before the tenth day of the month following the month in which the tips are received." I.R.C. § 6053(a); see Special rules apply for the purpose of collecting and calculating FICA taxes payable by employees with respect to tips. As indicated above, pursuant to I.R.C. § 3102(a), an employer must collect from each of its employees the employee tax on tips received by the employee which constitute wages. See 26 C.F.R. § 31.3102-3(a). I.R.C. § 3102(c) instructs the employer on how to perform this obligation and reads as follows:

                26 C.F.R. § 31.6053-1. 6  In that regard, unlike the situation where a tip is charged to a credit card, no record exists of the amount of a cash tip.  Cash receipts at restaurants, such as those operated by the Bubble Room, indicate only the cost of the underlying transaction, not any additional gratuity left by a satisfied customer.  Thus, only the satisfied customers and the tipped employees know the exact amount of cash tips received by the employees.  The tipped employees are in effect bound by an honor system when it comes to reporting to their employers cash tips that they have received
                

(c) Special rule for tips.--

(1) In the case of tips which constitute wages, subsection (a) shall be applicable only to such tips as are included in a written statement furnished to the employer pursuant to section 6053(a), and only to the extent that collection can be made by the employer, at or after the time such statement is so furnished and before the close of the 10th day following the calendar month (or, if paragraph (3) applies, the 30th day following the year) in which the tips were deemed paid, by deducting the amount of the tax from such wages of the employee (excluding tips, but including funds turned over by the employee to the employer pursuant to paragraph (2)) as are under control of the employer. [ ⁷]

(Emphasis added). Thus, in the case of the employee FICA tax, the employer need only consider those tips that "are included in a written statement furnished by the employee to the employer pursuant to section 6053(a)." 26 U.S.C. § 3102(c); see 26 C.F.R. § 31.3102-3. Unlike the employee FICA tax, however, there is no parallel provision which limits the employer's FICA tax liability to tips that are included in the written statement furnished by the employee.

As noted, I.R.C § 3121(q) defines tips as remuneration for both the employer and the employee FICA tax. It also sets calculation dates for when those tips are to be considered paid. The time at which tips are considered paid is important for the statute of limitations. Under most circumstances, once a return is filed, the IRS has three years to assess the amount of any tax. See I.R.C. § 6501(a). ⁸ I.R.C. § 3121(q) reads:

For purposes of this chapter, tips received by an employee in the course of his employment shall be considered remuneration for such employment (and deemed to have been paid by the employer for purposes of subsections (a) and (b) of section 3111). Such remuneration shall be deemed to be paid at the time a written statement including such tips is furnished to the employer pursuant to section 6053(a) or (if no statement including such tips is so furnished) at the...