The IRS often challenges the amount of income received by workers who are paid tips. The IRS’s Gaming Industry Tip Compliance Agreement Program (“GITCA Program”) provides a method for avoiding these disputes. But what happens if you opt out of the tip program? The Sabolic v. Commissioner, T.C. Memo. 2015-32, case provides the answer.
The Facts & Procedural History
Mr. Sabolic was a bartender employed at the Zuri Lounge in the MGM Grand Hotel and Casino (MGM Grand) in Las Vegas, Nevada, during tax years 2009-11.
Mr. Sabolic had previously participated in the IRS’s GITCA Program for over twenty years. Mr. Sabolic opted not to participate the the GICA Program in 2009-2011, as he felt that the automatic tip rate was too high given the economic conditions during the time.
Since Mr. Sabolic opted out of the GITCA Program, he was required to self-report his cash tips to his employer and keep personal records of how much he received in tips each shift.
The IRS audited Mr. Sabolic’s 2009-2011 income tax returns and determined that he underreported his tip income. The IRS found Mr. Sabolic’s recordkeeping to be insufficient to document his tip income, so it recomputed his income and increased his tax liability for each year.
Mr. Sabolic asked the tax court to review the IRS’s determination.
The Gaming Industry Tip Compliance Agreement Program
The GITCA Program is intended to promote compliance by the gaming industry employers and employees with the provisions relating to tip income and to reduce related tax disputes. The agreement is entered into by the employer who encourages employee participation. The employees then report their tip income at or above the established limits and taxes are imposed accordingly.
The IRS’s Reconstruction of Tip Income
Absent participation in the GITAC Program, employees who receive tip income are subject to the IRS’s general process for determining their income. That is what happened in this case.
But Mr. Sabolic was prepared. He argued that his records were sufficient. Mr. Sabolic had the set routine for recording his tips at the end of each shift:
- MGM Grand’s point-of-sales system would generate a receipt that stated how much he had earned in tips from credit cards and room charges (charged tips).
- He would cash out his charged tips receipt daily.
- Cash tips were not internally controlled by MGM Grand’s system, and so Mr. Sabolic would personally keep track of his cash tips for each shift.
- Mr. Sabolic would put any change from cash tips that he received in a glass jar.
- He would add together his cash tips and his charged tips and enter the total into the system when he punched out.
- He would tip the cashier any leftover change that he received.
- This amount would then be automatically reported to MGM Grand’s payroll department.
- He also kept daily a personal tip diary by recording the total on a slip of paper.
- His daily totals were recorded in whole numbers.
- Mr. Sabolic kept both the receipts from his charged tips and his contemporaneously recorded slips of paper for 2010 and 2011 and, for 2009, he kept only the contemporaneously recorded slips of paper.
- After he submitted his tip information to MGM Grand’s system, he would “tip out,” or give a portion of his tips to, the barback who had helped him that shift.
- He did not keep a contemporaneous log detailing how much he paid out to the barbacks.
- He gave the barbacks 10% to 20% of his total tips.
- His tip diaries show that he received tips of $21,849, $24,212, and $22,950 for tax years 2009-11, respectively. These amounts include the tips he gave to the barbacks, but do not include the change tips he gave to the cashiers when he cashed out his charge tip receipts.
In finding this recordkeeping process and records insufficient, the IRS recomputed Mr. Sabolic’s tip income using the following process:
- Obtain sales records from MGM Grand for the tax years at issue.
- Extract three figures for each year: Mr. Sabolic’s (1) total charged sales, which included both credit card and room charge sales; (2) total noncharged sales, which included both drinks purchased at full price in cash and all comped drinks; and (3) charged tips generated by the charged sales.
- Using the ratio of charged sales to charged tips, the IRS determined a “charge tip rate” for each tax year.
- Reduce the charge tip rate by 2% to arrive at the “noncharged tip rate” for each year.
- Reduced Mr. Sabolic’s total noncharged sales by a stiff rate of 15%, representing the frequency with which the IRS estimated that customers did not leave any tip or “stiffed” Mr. Sabolic.
- Apply the corresponding noncharged tip rate to the adjusted noncharged sales for each year in order to arrive at total noncharged tip income.
- Add the total noncharged tip income to the total charged tip income to arrive at total tip income for each year.
- Reduce the total tip income by 10% to account for the tip outs Mr. Sabolic gave to the barbacks at the end of each shift.
- Subtract the amount of tip income that Mr. Sabolic had reported on his respective tax returns.
The court noted that it had previously held that the IRS’s method of reconstructing taxpayers’ tip income was reasonable in other court cases. However, in this case, the court concluded that this method did not reflect Mr. Sabolic’s income as accurately as Mr. Sabolic’s own daily records.
The court based this determination on the records and Mr. Sabolic’s testimony, as it found him to be a credible witness. Thus, the court agreed that Mr. Sabloic’s recordkeeping system and records were sufficient and the best evidence in this case despite the IRS’s assertion to the contrary.