Pizza delivery driver Ara Lester knows he's required by U.S. tax law to report his tips, but he claims he never has and never will.

The seven-year veteran from Bemidji, Minn., said he's never worked in an operation where a tip-reporting policy was posted, nor for a supervisor who demanded he report a shift's gratuities.

"Never once has it been said that this is our policy, that this is what you have to claim," said Lester, 30, who works for Domino's Pizza. If his boss pressed him to report his tips, Lester said he'd "quit in a minute, laugh in his face and walk out of the store and go to work at Papa John's."

Tallying employee tip reports, Lester said, is his employer's problem, not his.

And on June 17, the U.S. Supreme Court essentially agreed with him. In a 6-3 decision in Fior d' Italia vs. United States, the Court ruled that, in an audit, the Internal Revenue Service can determine back taxes owed by an operator by estimating cash tips received by its employees based on an average of tips left on credit cards.

During its 1992 audit of Fior d' Italia, the IRS calculated that on average, a 14.5 percent average tip was left on credit card receipts. It applied that average to the San Francisco restaurant's gross sales and determined that some of the employees' cash tips had not been reported. In the end, Fior d' Italia received a tax bill for more than $23,000.

The restaurant appealed the ruling and defended itself successfully in two lower courts before the Supreme Court ruled otherwise.

Ever since a 1988 law put the onus on business owners to ensure their employees reported 100 percent of their tips, employers claimed that task was impossible.

The High Court's ruling that they indeed are accountable, said Peter Kilgore, senior vice president and general counsel for the National Restaurant Association, could have grave implications for restaurateurs.

"When managers have tried to get drivers to do this -- myself included -- it sparks the jokes about, 'What tips?' 'I got a tip for ya. Don't report your tips."

J.W. Callahan
Association of Pizza Delivery Drivers

Kilgore believes the law only holds employers accountable for reporting what employees report to them, regardless of whether those reports are accurate.

The NRA urges operators to teach responsible tip reporting practices, he said, and it sells instructional materials to assist in that effort. However, he added, owners can only do so much.

"The real problem is that you can say it until you're blue in the face, but if employees are not going to report all their tips, then the employer's not going to know it, particularly the cash tips," said Kilgore, from his Washington, D.C. office.

Bill Green, co-owner of Mamma Rosa's, a pizzeria in Salem, Ind., said he doesn't have the time to be a tip cop at his pizzeria.

"Our employees are aware they are supposed to report their tips, but whether they do for sure is hard to know," said Green. "In my opinion, as a business owner, I'm not responsible to be a collection agency for the government."

Credit the cash businesses

Of restaurants whose employees receive tips, pizza delivery drivers may be the most challenging to monitor. Drivers collect gratuities off premise and typically are tipped in cash.

Additionally, said, J.W. Callahan, a Georgia-based veteran delivery driver and the founder of the Association of Pizza Delivery Drivers, even when easily tracked payments such as checks and credit cards are used, customers still regularly tip drivers in cash.

Credit card and check payments represent a small percentage of pizza payments, according to Dale Hoyer, president and co-founder of Wichita, Kan.-based Franchise Services Company (FSC). In other words, precise tracking of cash tips in pizza delivery is virtually impossible.

"How do you get around that problem outside of following them around or calling customers and asking what they tipped?" asked Hoyer, whose company provides bookkeeping and financial reporting services for restaurants. "I don't think there's going to be a way to do that."

Lester said that less than 2 percent of the deliveries he makes each week are paid by credit card, and just as happens with Callahan, "most of those people tip with cash."

Despite such claims, Hoyer doesn't believe that the problem of underreported tips is as widespread in the foodservice industry at large as some might think. When he worked as a controller for Pizza Hut, Hoyer said the company applied formalized educational and review policies to ensure employees were reporting all their tips.

His clients, many of whom are pizza chains, employ similar practices, he added, but he knows that no system is entirely perfect. Education has to go beyond managers and supervisors and straight to table servers and delivery drivers, he said.

Kilgore doesn't believe underreported gratuity is an industry-wide problem either.

"We've never done any survey on this, but I'd be highly skeptical that this is a widespread occurrence," Kilgore said. Responding to Lester's claim that he'd never been told by a supervisor to report tips, he asked, "What does the employer gain by that? If there are no tips reported and it's a restaurant that has tipped employees, that's the first thing the IRS is going to see when the employer files its tip reporting."

This is the law

Thomas Burger, director of employment tax for the IRS Small Business Self-Employed (SBSE) Division in Washington, D.C., admits that operators -- and tipped employees especially -- commonly misunderstand how much of their tips must be reported.

"The law basically requires any employee that makes more than $20 a month in tips to report all of those tips to their employer by the tenth day of the following month," said Burger. "Tips are considered wages, and the employer's obligation is to report what is reported to him by the employee."

The IRS provides Form 4070 to assist employees in recording and reporting their tips on a monthly basis, but employees aren't legally bound to use it.

"It's just a tool we provide them," he said.

During audits, Burger said he's also heard operators and tipped employees claim they thought they were required to report just 8 percent of their gross sales as tips, not 100 percent as the law states. Though a widely held belief, he said, it's completely false.

The "8 percent rule," as it's known throughout the industry, works this way:

The U.S. Department of Labor allows tipped restaurant employees to be paid less than minimum wage (i.e. table servers are commonly paid $2.13 per hour) because it knows gratuities added to that reduced wage will raise that wage to at least the mandated minimum wage.

The 8 percent rule "is an employer obligation only," said Burger. "In order to get to that minimum wage, the employer must certify that the employee is making up the difference between the (hourly rate) and the minimum wage on an hourly basis with tips."

Despite the efforts of the IRS and the NRA to provide educational materials on tip-reporting law, APDD's Callahan says the tax code is both intimidating and difficult to understand, and that operators do precious little if anything to educate their employees about its intricacies. "I don't fully understand it myself -- not even close in fact."

"(Y)ou can say it until you're blue in the face, but if employees are not going to report all their tips, then the employer's not going to know it ... ."

Peter Kilgore
General Counsel, National Restaurant Association

As Burger pointed out, however, ignorance doesn't relieve a citizen of his tax burden.

"If someone's not voluntarily complying, whether that's an employee or employer, they run the risk of an audit," said Burger, adding that the IRS doesn't seek out any particular company, large or small, for audits. "If you've got 10 restaurants in a given geographical area reporting an average tip of 15 percent, and you've got another restaurant reporting just 2 percent, then that one's going to float to the top of the (audit) pile. That's a red flag."

Despite the bickering between the IRS and the restaurant industry, the IRS offered an olive branch of sorts, dubbed the Tip Reporting Alternative Commitment (TRAC).

According to the NRA's Web site, under the TRAC, a restaurateur who signs a TRAC assumes greater responsibility for getting employees to report their tips.

In return, the IRS agrees not to bill the restaurant for FICA taxes on allegedly unreported tips unless it has first examined employees' records.

Along the same lines and in a more operator self-policing fashion, the NRA created the Employer's Tip Reporting Alternative Commitment or EmTRAC.

Employers who develop their own EmTRAC are afforded the same protections provided by TRAC, and they gain a little more flexibility to develop tip-reporting procedures that better suit their needs.

Each employer's customized EmTRAC must be approved by the IRS, but it doesn't require an employer to enter into a formal written contract with the IRS.

Whichever one an operator chooses, Kilgore said, the goals of avoiding employer-first audits and aggregate tip estimates are accomplished.

"Any audit would begin with an employee tip examination ... and that's exactly the way we believe the law should have been interpreted by the Supreme Court," Kilgore said.

What corporate policy?

Few operators were willing to speak either on or off the record about their tip reporting policies or their enforcement because of concerns that public discussion of such matters would catch the attention of the IRS.

An e-mail request for information about tip-reporting policies at Pizza Hut, Domino's Pizza, Papa John's and Little Caesars was denied. Responding for spokespersons at all four companies Patty Sullivan, spokesperson at Dallas-based Pizza Hut, deferred all questions to the NRA's Kilgore.

Mamma Rosa's Green, however, said he wasn't concerned about speaking because he believes he operates well within law. When employees are hired for tipped positions, they receive IRS 4070 forms along with a written reminder and occasional verbal reminders.

At the end of every shift, he added, employees are required to log their tips totals into the POS system, a practice Hoyer said is becoming increasingly common.

Those systems are good, Callahan agreed, but accurate reporting still boils down to employee honesty, which he said is sometimes discouraged at the supervisor level.

"The reality is that managers are not encouraged to require us to do it at this time," he said. "When managers have tried to get drivers to do this -- myself included -- it sparks the jokes about, 'What tips?' 'I got a tip for ya. Don't report your tips.'

"The result is no one really reports tips, no one is ever going to report tips, and all of the legislation in the world won't change it. That's just the facts."

Of the more than 200 drivers Lester said he's met during his career, he knows none of them who reported their tips. And not only does he say he'll never report them, he's confident the IRS has neither the manpower nor the desire to pursue a small fish like him.

"When you've got Enron paying no taxes and Exxon paying $10,000 in taxes on a billion dollars in profit, why should I pay taxes?" he said. "Drivers claiming tips ... it's something that's just not done."

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