330 West Hubbard Rest. Corp. v. U.S., PLAINTIFF-APPELLANT

• Decision Date: 22 February 2000
• Docket Number: PLAINTIFF-APPELLANT,DEFENDANT-APPELLEE,No. 99-1137,99-1137
• Citation: 203 F.3d 990
• Parties: (7th Cir. 2000) 330 WEST HUBBARD RESTAURANT CORPORATION, DOING BUSINESS AS COCO PAZZO,, v. UNITED STATES OF AMERICA,
• Court: U.S. Court of Appeals — Seventh Circuit

Page 990

203 F.3d 990 (7th Cir. 2000)

330 WEST HUBBARD RESTAURANT CORPORATION, DOING BUSINESS AS COCO PAZZO, PLAINTIFF-APPELLANT, v. UNITED STATES OF AMERICA, DEFENDANT-APPELLEE.

No. 99-1137

U.S. Court of Appeals, Seventh Circuit

Argued June 8, 1999

Decided February 15, 2000

As Amended February 22, 2000

Tracy J. Power, Thomas W. Power (argued), Power & Power, Arlington, VA, for Plaintiff-Appellant.

Bruce R. Ellisen (argued), Jeffrey Meyer, Department of Justice, Tax Division, Appellate Section, Washington, DC, for Defendant-Appellee.

Before Coffey, Easterbrook and Rovner, Circuit Judges.

Coffey, Circuit Judge.

Plaintiff 330 West Hubbard Restaurant Corporation operates a restaurant named "Coco Pazzo" in Chicago, Illinois.¹ Coco Pazzo filed this action in the Northern District of Illinois challenging the Internal Revenue Service's (IRS's) aggregate method of assessing and collecting the employer's share of Federal Insurance Contribution Act (FICA) taxes on tips received by its restaurant employees as well as seeking a refund of a partial payment of employment FICA taxes and an abatement of the balance of the taxes assessed. The IRS filed a counterclaim for unpaid FICA taxes in the amount of $85,104.

On November 23, 1998, the district court granted the government's motion for summary judgment; thereby upholding the IRS's authority to collect employer FICA taxes through an aggregate method and confirming the taxpayer's obligation to pay the balance of the FICA taxes assessed against it. We affirm.

I. BACKGROUND

A. Employer and Employee FICA Taxes

FICA imposes a 7.65% tax on the income of individual employees. See 26 U.S.C. sec. 3101. FICA also imposes an excise tax of 7.65% on employers "with respect to having individuals in [their] employ." See 26 U.S.C. sec. 3111; 26 C.F.R. sec. 31.3111-4. Employers collect the employee's share of FICA taxes (hereinafter employee share) by deducting the appropriate amount from their employees' wages "as and when paid." See 26 U.S.C. sec. 3102(a). Employers pay the employer's share of FICA taxes (hereinafter employer share) based on the wages paid to their employees. See 26 C.F.R. sec.sec. 31.3111-1, 31.3111-4.

Paying both the employee and employer FICA taxes² is a difficult task for employers in the restaurant industry where employees earn much of their income from tips rather than from a salary paid by the restaurant. Only in rare instances do restaurant employers have first-hand knowledge of how much actual tip income their employees earn. Thus, the usual practice in the restaurant industry is for the employers to rely on their employees to furnish an accurate statement of the amount of tips they collect. See 26 U.S.C. sec. 3102(c)(1).

Towards that end, employees are required to report all their tips to their employers, using IRS Form 4070 (Employee's Report of Tips to Employer) or a similar written form. See 26 U.S.C. sec. 6053(a); 26 C.F.R. sec. 31.6053-3(a). Employers then use these reports to determine the amount of money to withhold from their employees' paychecks to cover the employee share. See 26 U.S.C. sec. 3102(a) & (c)(1); 26 C.F.R. sec.sec. 31-3102-1(a), 31-3102-3(a)(1). Employers also use the tip reports to determine how much FICA taxes they are obligated to pay.³ See 26 U.S.C. sec. 3111.

When employees underreport their tips, restaurants under-withhold the employee share due under section 3101, and thus also underpay the employer share due under section 3111. Under these circumstances, restaurants are not culpable for underpayment because they have no choice but to rely on their employees' reports. Thus, the FICA statute provides that when employees fail to furnish tip reports or their reports are incomplete or inaccurate, their employers are obligated to pay employer FICA taxes based only on the amount of income their employees actually report. See 26 C.F.R. sec. 31.3111-3.

This principle--that employers are only liable for FICA taxes on the tip income actually reported by their employees--is circumscribed in that once the IRS determines that the employee's tip income is greater than that reported by the employee and then sends the employer a notice and demand letter, FICA taxes on those wages are due. See 26 U.S.C. sec. 3121(q).

In assessing unreported tip income, the IRS has decided that it is too burdensome to determine the amount of underreporting by each employee. Instead, the IRS audits the restaurant itself and assesses the employer share based on the aggregate amount of unreported tips from all the restaurant's tipped employees. This has proven to be a controversial practice. Compare Bubble Room Inc. v. United States, 159 F.3d 553 (Fed Cir. 1998) (approving the practice); Morrison Restaurants Inc. v. United States, 118 F.3d 1526 (11th Cir. 1997) (same), with Fior D'Italia Inc. v. United States, 21 F. Supp. 2d 1097 (N.D. Cal. 1998) (disapproving the practice); Quietwater Entertainment v. United States, No. 3:98CV160/RV, 1999 U.S. Dist. LEXIS 11350 (N.D. Ga. June 25, 1999) (same).

B. Coco Pazzo's Employer FICA Taxes

On its 1993, 1994, and 1995 Form 8027 (Employer's Annual Information Return of Tip Income and Allocated Tips) Coco Pazzo declared both its total charge tips and its total tips reported by employees. Coco Pazzo reported charge tips of $392,725.17 for 1993, $471,600.48 for 1994, and $548,460.64 for 1995--$1,412,786.29 altogether. For these same years, according to Coco Pazzo's Form 8027 filings, Coco Pazzo employees reported total tips of $96,228 for 1993, $155,719.20 for 1994, and $198,885.50 for 1995--$450,837.70 altogether. By simply comparing these numbers it was obvious to the IRS that Coco Pazzo employees had underreported their tips by at least $961,948.59.

In the present case, Coco Pazzo collected all of its employees' tips (both cash tips and tips charged to credit cards) each day and redistributed them at the end of the week. Each employee received a percentage of the tip pool based on his or her position (waiter, bartender, etc.). Coco Pazzo's records of its tip pooling indicate that it collected and redistributed $434,876.48 in 1993, $520,424.35 in 1994, and $601,000.32 in 1995--$1,556,301.15 altogether.

By simply subtracting the amount of tips Coco Pazzo reported⁴ from the actual amount it collected, the IRS was able to precisely determine the amount of tips Coco Pazzo employees had underreported, $1,112,453.92. The IRS determined that based on the unreported $1,112,453.92, Coco Pazzo owed additional employer FICA taxes in the amount of $85,104.

On June 12, 1996, pursuant to 26 U.S.C. sec. 3121(q), the IRS sent Coco Pazzo a notice and demand letter for this amount. In response, on August 5, 1996, Coco Pazzo paid $1.53, which was the employer FICA tax for one employee for one quarter. This $1.53 represented a partial payment under protest of the entire amount assessed. See Flora v. United States, 362 U.S. 145, 162 (1960). On October 1, 1996, Coco Pazzo filed IRS Form 843 (Claim for Refund and Request for Abatement), requesting a refund of the $1.53 and an abatement of the remainder of the assessment. See 26 C.F.R. sec. 31.6402-2(a). Coco Pazzo then waited the requisite six months before bringing suit. See 26 U.S.C. sec. 6532(a)(1); 26 C.F.R. sec.sec. 301.6532-1(a)(1), 301.6402-2(a)(1). On January 13, 1998, Coco Pazzo filed this action for refund under 26 U.S.C. sec. 7422 in the Northern District of Illinois. The IRS filed a counterclaim for the balance of the unpaid FICA taxes.

Both parties agreed that the failure of Coco Pazzo's employees to file accurate reports of their tip income as required by 26 U.S.C. sec. 6053 did not insulate Coco Pazzo from its obligation to pay employer FICA taxes on the unreported tip income. Both parties recognized that 26 U.S.C. sec. 3121(q) clearly gives the IRS the authority to collect employer FICA taxes on unreported employee tip income. See Morrison, 118 F.3d at 1529. The question before us concerns only the ability of the IRS to use the aggregate method to assess Coco Pazzo's employer share FICA taxes.

In deciding whether the IRS could collect employer FICA taxes based on aggregate unreported employee tip income, the district court examined 26 U.S.C. sec. 6205. The trial judge determined that this section delegates to the Secretary of the Treasury the power to prescribe regulations when dealing with an employer suspected of underpayment of FICA taxes. Consistent with section 6205, the judge concluded that the IRS implemented its authority to prescribe regulations for adjustments without mentioning the need for assessing individual employee liability. See 26 C.F.R. sec. 31.6205-1(a)(1). The district court, thereafter, determined that the IRS was authorized to make an aggregate assessment concerning the amount of employer FICA taxes due. On November 23, 1998, the district court granted the IRS's motion for summary judgment. Coco Pazzo appeals.

II. ISSUE

On appeal, Coco Pazzo argues that the district court erred in holding that the IRS was authorized under 26 U.S.C. sec.sec. 3121(q) and 6205 to assess employer FICA taxes based on an aggregate estimate of the tip income received by its employees without first determining the amount of underreporting by individual employees.

III. ANALYSIS

A. Standard of Review

We review a district court's decision to grant summary judgment, as well as its interpretation of the tax code, de novo. See Tesch v. County of Green Lake, 157 F.3d 465, 471 (7th Cir. 1998) (summary judgment); Akrabawi v. Carnes Co., 152 F.3d 688, 695 (7th Cir. 1998) (tax code). In general, summary judgment is appropriate when the pleadings, answers, interrogatories, affidavits, and other materials demonstrate that there exists "no genuine issue as to any material fact" and that the moving party is entitled to judgment as a matter of law. See Fed. R. Civ. P. 56(c). In determining whether a genuine issue of material fact exists, we consider the evidence in the...