Lir Management Corp. v. U.S.
| Decision Date | 25 February 2000 |
| Docket Number | No. 96 Civ. 3508(JES).,96 Civ. 3508(JES). |
| Citation | 86 F.Supp.2d 340 |
| Parties | LIR MANAGEMENT CORP. d/b/a Pete Smith's, Arryl Operating, Inc. d/b/a Toots Shor, Sports Garden Rest, Inc., d/b/a Charley'o, 729 7th Ave. Houlihan's Operating, Inc. d/b/a Houlihan's River Restaurant, Inc. d/b/a Houlihan's, 380 Lexington Operations, Inc. d/b/a Houlihan's, Chicago Restaurant, Inc., and Complex Management, Inc., Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — Southern District of New York |
Lewis R. Cohen, New York, NY, for Plaintiffs; Power & Power, Arlington, VA, Tracey J. Power, Thomas W. Power, of Counsel.
Mary Jo White, United States Attorney, for Southern District of New York, New York, NY, for Defendants; Edward Scarvalone, Assistant United States Attorney, of counsel.
Plaintiffs LIR Management Co. ("LIR Management"), Arryl Operating, Inc. ("Arryl"), Sports Garden Rest, Inc. ("Sports Garden"), 729 7th Avenue Houlihan's Operating, Inc. ("7th Avenue Houlihan's"), River Restaurant, Inc. ("River Restaurant"), 380 Lexington Operations, Inc. ("380 Lexington"), Chicago Restaurant, Inc. ("Chicago Restaurant"), and Complex Management, Inc. ("Complex Management") (collectively, "Taxpayers") bring this suit against defendant United States of America (the "government") challenging defendant's assessment, pursuant to 26 U.S.C. § 3121(q), of plaintiffs' portion (the "employer-only portion") of Federal Insurance Contribution Act ("FICA") taxes assessed against and collected from plaintiffs on unreported tips of plaintiffs' employees in the aggregate as estimated by the Internal Revenue Service ("IRS") for the years 1989, 1990, 1992, and 1993. Pursuant to Rule 56 of the Federal Rules of Civil Procedure, the parties cross-move for summary judgment. For the reasons set forth below, defendant's motion for summary judgment is granted and plaintiffs' motions for summary judgment are denied.
Plaintiffs operate restaurants that employ workers, such as waiters, bartenders, and other restaurant staff who receive tip income. See Complaint at ¶ 5; Answer and Counterclaim ("Answer") at ¶ 4. Under the Internal Revenue Code ("IRC" or "Code"), plaintiffs are obligated to pay the employer-only portion of the FICA tax based upon each employee's wage income. This wage income includes both wages paid by the restaurant to each employee and the employee's tip income. The dispute in this case involves unreported tip income in 1989 and 1990 for plaintiffs Chicago Restaurant and Complex Management, and in 1992 and 1993 for the remaining plaintiff corporations. See Complaint at ¶¶ 4, 7, 10; Answer at ¶¶ 4, 7, 10. The forms filed by plaintiffs to the IRS for each of these years on their face reveal underreporting of tip income by plaintiffs' employees. See Declaration of Gerald Werkman ("Werkman Decl.") at ¶ 10.
Following the determination of underreporting of tip income by plaintiffs' employees, the IRS employed two methods for calculating the employer portion of the FICA taxes owed by plaintiffs' restaurants. See Plaintiffs' Motion for Summary Judgment ("Pl.Mem") at 4-5; Werkman Decl. at ¶¶ 14-20. One method employed by the IRS simply assessed the discrepancy between the total tips reported by plaintiffs Chicago Restaurant and Complex Management's employees and the amount of tips reported by plaintiffs on their credit card receipts (hereinafter referred to as "total charged tips") that appeared on the face of their reports to the IRS. See id.
The other method employed by the IRS assessed plaintiffs LIR Management, Arryl, Sports Garden, 7th Avenue Houlihans, River Restaurant, and 380 Lexington for the tax years 1992 and 1993. See id. The IRS computed the employers' share of unpaid FICA taxes on unreported tips on Form 8027s and the "McQuatters Formula" which is derived from McQuatters v. Commissioner, 32 CCD Tax Ct. Mem. 1122, 42 P-H Tax Ct. Mem. 1078 (1973). See id. Essentially, the IRS compared the total charged tips for each restaurant with the total tips reported by the restaurants' employees. See id. Where it was determined that the employees' total reported tips were less than the reported charged tips, the IRS computed a "Charged Tip Ratio" by dividing the total charged tips by the total charged receipts. See id. The Charged Tip Ratio was then reduced by 2% to determine the "Estimated Cash Tip Rate." The restaurant's total cash receipts were determined by subtracting the total charge card receipts from the restaurants' total gross receipts. See id. The Estimated Cash Tip Rate was then applied to the restaurants' total cash receipts, resulting in the "Estimated Total Cash Tips." See id. This amount was then added to the total charged tips amount to determine the "Total Charged and Cash Tips." See id. The total reported tip income was then subtracted from the Total Charged and Cash Tip amount, resulting in the "Total Unreported Tip Income," which was used as the basis for assessing in the aggregate the total amount of tips unreported by plaintiffs' employees and subject to the 7.65% employer paid portion of FICA. See id.
By letters dated April 17, 1995, the IRS, pursuant to IRC § 3121(q), served plaintiffs with Notice and Demand for the employer share of FICA taxes allegedly due on tips unreported by plaintiffs' employees. See Complaint at ¶¶ 10, 12; Werkman Decl. at ¶ 13-14. The IRS determined that the above plaintiffs owed the following:
TAXPAYER 1992 1993
LIR Management $ 9,445.00 $10,027.00
Arryl $ 5,676.00 $ 6,240.00
Sports Garden $ 8,453.00 $ 8,810.00
7th Avenue Houlihans $ 9,013.00 $11,151.00
River Restaurant $10,443.00 $ 9,961.00
380 Lexington $ 9,543.00 $ 5,746.00
The plaintiffs did not pay the full amount of taxes assessed, but remitted $1.53 representing partial payment under protest of the entire amounts assessed for the employer share of FICA taxes as provided for by Flora v. United States, 362 U.S. 145, 80 S.Ct. 630, 4 L.Ed.2d 623 (1960) and Steele v. United States, 280 F.2d 89 (8th Cir.1960). On August 14, 1995, the plaintiffs filed claims for refund of the $1.53 partial payment made by each plaintiff and abatement of the full amount of the taxes assessed on the April 17, 1995 Notice and Demand.
The second method used by the IRS, as discussed above, assessed plaintiffs Chicago Restaurant and Complex Management for employer portion of FICA taxes for the years 1989, 1990. See Complaint at ¶ 15; Werkman Decl. at 15-17. The IRS derived the employer portion of FICA taxes by subtracting the total tips reported from the total charged tips of the Forms 8027 filed by the restaurants. See Werkman Decl. at ¶ 15-17. By letters dated July 26, 1993, the IRS served plaintiffs Chicago Restaurant and Complex Management with Notice and Demand for the employer share of FICA taxes allegedly due on tips unreported by employees of the plaintiffs. See Complaint at ¶ 15; Werkman Decl. at ¶ 15-17. The following amounts were due for the above plaintiffs pursuant to IRC § 3121(q).
TAXPAYERS 1989 1990 TOTAL
Chicago Restaurant $3,609.16 $3,663.13 $7,272.29
Complex Management $5,315.58 $4,487.26 $9,802.84
On December 16, 1995, Chicago Restaurant and Complex Management paid the full amounts assessed. See Complaint at ¶ 18. On July 26, 1995, plaintiffs Chicago Restaurant and Complex Management filed claims for refund of the full amounts paid pursuant to the July 26, 1993 Notice and Demand letters. See id. at ¶ 19.
Under both methods employed here, the IRS did not apportion the taxes assessed among tipped employees, nor did it credit the earnings of such employees with tip income. The IRS did not make any inquires into the restaurants' individual employees to find out who underreported tip income or to assess upon those employees' additional FICA taxes. Further, the IRS admits that it did not conduct any type of regression analysis, and that it has no way of knowing which employees underreported tip income. Rather, the employer FICA taxes asserted against the above plaintiffs were determined on an aggregate basis against the gross earnings of respective restaurant units.
Plaintiffs do not contest the reasonableness of methodologies employed by the IRS. In fact, during the course of the instant litigation, plaintiffs stipulated that they "agree that the Internal Revenue Service's ("IRS") calculation of the amount of aggregate unreported tip income of all plaintiffs' employees collectively ... is reasonable" and that "plaintiffs agree that if the Court decides in this proceeding that the IRS can access additional FICA taxes based on a reasonable estimate of the aggregate reported tip income of its employees collectively, then the IRS' calculation of the aggregate unreported tip income ... would constitute a valid assessment." Defendant's Notice of Motion dated June 10, 1997 at Ex. B, ¶¶ 1, 3. Thus, the only issue for the Court to consider is whether the IRS had the authority to employ the two methods described above in the first instance.
In support of their cross-motion for summary judgment, plaintiffs contend that defendant's assessment was erroneous and illegal because the IRS lacks the authority to assess plaintiffs for the employer-only portion of FICA taxes on unreported tip income without auditing and assessing each employee, and without crediting the Social Security account of the employees whose unreported income gave rise to the assessment of the employer FICA tax. Furthermore, plaintiffs contend that only an assessment that determines individual tip earnings and credits individual wage history records for such tip earnings would be consistent with both the specific legislative purpose of treating tips as wages for Social Security purposes and the purpose of the Social Security Act. In addition, plaintiffs Chicago Restaurant and...
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