Tipping the Scales of Fair Play by IRS

When Margaret Neuman opened her mail last month, she received an unwelcome surprise: a letter from the IRS claiming she owed nearly $2,500 in taxes and penalties based on tips she received in 2003 as a waitress at the Palms.

Neuman was among a handful of Palms workers who received similar letters from the IRS last month.

In Neuman's letter, the IRS claimed she failed to report about $8,000 in tips on her tax form. But Neuman didn't estimate or track her own tips.

She didn't have to because she -- like thousands of other workers in Las Vegas who receive tip income -- relies on tip estmates her employer gives the IRS.

After digging through the Palms' electronic printouts of her pay stubs, Neuman figured out what went wrong.

First, the IRS estimated her tips on a swing shift schedule rather than Neuman's day shift of $6.75 in tips per hour. Second, the IRS failed to account for the fact that Neuman was a restaurant hostess, making no tips, for most of that year and then switched to being a food server, a tipped position, in mid-July. Instead, the IRS estimated her tips based on an entire year as a server.

Neuman's mother, Margaret Labotka, said she was "shocked" and "appalled" that the IRS would take the time to dissect her daughter's tax return. Neuman, a student at UNLV, made about $16,500 in 2003, including tips. She still works part time at the Palms' Garduno's restaurant.

"They're picking on people who are tip earners," Labotka said of the IRS. "What about the millionaires with all their tax loopholes and fancy attorneys?" The IRS "should get all the information before they send something like this out."

The IRS by law won't discuss individual tax returns or issues with specific hotels. Still, IRS officials suggested that such errors may lie with the resorts.

Nevada hotels, including the Palms, signed tip tax agreements with the IRS that allow employees to pay set tax rates based on estimated tips provided by each of the properties.

The so-called tip compliance agreement, struck in 2003 after much wrangling between the IRS and the Nevada gaming industry, established tax rates that vary according to hotel, hours worked and job shift.

A little-known requirement of the agreement is that each hotel supplies detailed information on the work history of each tipped employee at the end of the calendar year. The mammoth list -- which typically includes the hours each employee worked in a specific position, accounting for job and shift changes -- allows the IRS to make sure workers aren't skipping out of reporting their tips.

When workers turn in their tax returns for that year, the IRS compares figures from the workers' W-2 forms with their work history information supplied by the hotels. If the numbers don't match, the IRS will typically send a letter asking the worker to clarify the discrepancy or pay up.

Sometimes hotels make mistakes on the work history information supplied to the IRS, officials with the agency say. In that case, that information and the W-2 figures may not match, they say.

In most cases, the IRS isn't second-guessing employers' W-2 forms.

But Nevada's gaming industry is a special case. With its army of tipped workers and a high potential for unreported tips, the tip agreement estimates those tips up front, allowing the IRS to capture income that might otherwise go unaccounted for.

Only about 80 percent of Nevada's more than 100,000 tipped hotel workers choose to participate in the tip agreement, which is voluntary unless a hotel mandates that workers take part, according to the IRS.

Those who choose not to participate must add up their tips for the year and could be asked for a log to account for the tips they reported. The IRS has even created a separate form for workers to log their tips.

The IRS believes that some people who don't participate in the tip agreement may be avoiding reporting tips altogether.

Those workers who opt out of the tip agreement will have lower earnings on their W-2 and space to fill in the tips earned that year. If those tips are left out of the equation, the IRS can check the work history sheet to confirm whether tips were earned.

In Neuman's case, that double-checking process means some workers who report their income and tips correctly could be caught in the middle of an accounting error.

The workers who were sent letters from the IRS ended up changing jobs at some point during the tax year in question, which ended up affecting the tip amount the Palms reported at the end of the year, Palms General Manager Jim Hughes said.

Hughes said the Palms has sent a response to the IRS on behalf of employees who received letters to correct the errors.

Hughes said he's not aware of any other tip discrepancies with the IRS since the property opened in 2001. The Palms tends to have less turnover than is typical in the industry, he said.

Labotka said her daughter received from the Palms a printout of her hours and tips earned that year to give to the IRS.

Some tipped workers may be intimidated by the tax agency or may not take the time to sift through their work histories to find out what went wrong, Labotka said.

Her accountant initially suggested that she simply pay her daughter's tax bill rather than dispute the IRS' claim.

"He said, 'You don't want to get into a fight with the IRS.' "

Taxpayers who receive clarification letters from the IRS have the right to dispute their tax bill, IRS spokesman Bill Brunson said.

The tip agreement was created to simplify the process for hotels and workers alike as well as ensure compliance with the law, he said.

The IRS has a Las Vegas office with experts on tip compliance and maintains a telephone hotline in Las Vegas to answer questions on the tip compliance program. The hotline number is (702) 868-5200.

"We get back to the employee within 24 hours," Brunson said. The IRS also meets with casino managers and holds workshops for workers, he said.

Las Vegas attorney Gregory Kamer, who has represented casinos in employment disputes, said the tip agreement is fair and has solved a lot of reporting problems.

"This takes the burden off the individual tip earner" to account for their tips, Kamer said. "I think it works for everybody, though there may be some exceptions to that."

Workers are much better off under the tip tax agreements even though they would probably be reluctant to admit it, tax attorney and UNLV Boyd School of Law professor Steve Johnson said.

"There's no doubt that employees typically receive more in tips (on average) than the amount of tips they are required to report under the agreements," Johnson said. "The IRS in essence is accepting a lesser amount in taxes in order to make its administrative life a whole lot easier. Tip agreements are necessarily imprecise but frankly, a case-by-case auditing and adjudication is imprecise" as well as expensive, he said.

Without the agreement, many tip earners in Nevada would be targeted for audits like they were before the agreement was reached, he said. It isn't unheard of for workers in some tipped industries to report as little as half of the tips they actually earn, he said.

Some people still risk not reporting their tips, knowing that they may not be audited because the IRS lacks the resources to audit every or even most tip earners, Johnson said.

The tip agreements still haven't been popular because some workers "have convinced themselves that they're being cheated under the agreement," he said.

The IRS shouldn't be second-guessing workers who correctly report their taxes and tips using their W-2 forms, Labotka said.

The agency is wasting resources questioning tip earners over a few thousand dollars when it could be focused on closing tax loopholes for wealthy taxpayers and corporations, she said.

"The rich are getting all the tax breaks," she said.