                               T.C. Memo. 2015-32



                         UNITED STATES TAX COURT



                    ALAN SABOLIC, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22187-13.                         Filed February 26, 2015.



      Alan Sabolic, pro se.

      Wesley J. Wong, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      KERRIGAN, Judge: Respondent determined the following deficiencies and

penalties with respect to petitioner’s Federal income tax for tax years 2009-11:
                                         -2-

                      [*2]                                Penalty
                      Year           Deficiency         sec. 6662(a)
                      2009              $5,372             $1,074
                      2010               4,975                995
                      2011               5,505              1,101

      Unless otherwise indicated, all section references are to the Internal

Revenue Code in effect for the tax years at issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure. We round all monetary amounts to

the nearest dollar.

      The issues for our consideration are (1) whether petitioner received

unreported tip income in tax years 2009-11 and (2) whether petitioner is liable for

accuracy-related penalties under section 6662(a).

                               FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. Petitioner resided

in Nevada when he filed the petition.

      Petitioner has been employed as a bartender for over 20 years. He was

employed at the Zuri Lounge at the MGM Grand Hotel and Casino (MGM Grand)

in Las Vegas, Nevada, during tax years 2009-11. He would serve drinks to

customers who sat at the six stools at his bar and to those who would walk up to

the counter. In front of the stools were video poker machines. If a customer was
                                        -3-

[*3] sitting at a stool and actively gambling on the video poker machine, petitioner

would serve him or her a complimentary drink (comp). Most of petitioner’s drinks

served were comps. Petitioner did not work with waitresses and did not fill their

orders.

      Petitioner worked Monday through Thursday from 6 p.m. until 2 a.m. with

an hour break each day for all three tax years. At times during the tax years at

issue, petitioner varied from his usual routine to take vacations or work flexible

hours. Each MGM Grand worker had an employee identification number and

terminal where he or she swiped in when arriving and swiped out when leaving or

taking a break.

      When a customer ordered a drink from petitioner, he entered the sale into

MGM Grand’s point-of-sales system under his unique employee identification

number. When he provided a customer with a comp, MGM Grand’s point-of-sales

system would internally record it with a price discounted from the usual retail

price of a drink. For example, if he entered a sale from a domestic beer provided

to a paying customer, the system internally recorded it at $8. But, if he entered a

sale from the same domestic beer provided as a comp, the system internally

recorded it at $4. The system also tracked the customer’s payment for the drinks
                                         -4-

[*4] purchased, including whether the purchase was made with a credit card or

cash, and the amount of any tip paid by credit card or room charge.

Daily Log

      During the years at issue petitioner opted not to participate in the Internal

Revenue Service’s (IRS) Gaming Industry Tip Compliance Agreement Program

(GITCA Program).1 Petitioner participated in the GITCA Program for over 20

years, but he opted out of it during the tax years at issue because he felt that the

automatic tip rate was too high given the economic conditions during that time.

      Since petitioner 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. Petitioner had a set routine of how he recorded 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 petitioner


      1
        The GITCA Program is an IRS program that sets an automatic tip rate for
participating employees. Rather than requiring that participants keep records and
report their actual tip income, the IRS allows the employer’s payroll department to
multiply the number of hours worked by GITCA Program participants by the
applicable tip rate to arrive at taxable tip income which is then reported on the
participants’ Forms W-2, Wage and Tax Statement.
                                        -5-

[*5] would personally keep track of his cash tips for each shift. Petitioner 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.

      Petitioner kept both the receipts from his charged tips and his

contemporaneously recorded slips of paper for 2010 and 2011. For 2009 he kept

only the contemporaneously recorded slips of paper. After he submitted his tip

information to MGM Grand’s system, petitioner 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. Petitioner

gave the barbacks 10% to 20% of his total tips. Petitioner’s tip diaries show that

petitioner 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.
                                         -6-

[*6] Tax Returns

      Petitioner filed timely tax returns for all three years at issue. He hired a tax

return preparer to aid him in this process. Each year he would provide his return

preparer with the Form W-2 generated by MGM Grand. The Form W-2 showed

how much he had earned in tips for that year on the basis of the amounts that he

reported to MGM Grand at the end of each shift. The return preparer used that

information to complete petitioner’s Form 1040, U.S. Individual Income Tax

Return. Each year petitioner reduced the total tips that he received by

approximately 10% to account for the tip outs to the barback at the end of each

shift. In accordance with his Forms W-2 petitioner reported income from tips of

$18,110, $23,941, and $21,926 for tax years 2009-11, respectively. He claimed

deductions for the tip outs of $1,811, $2,394 and $2,193 for tax years 2009-11,

respectively.

Respondent’s Calculation

      Respondent determined that petitioner had underreported his tip income for

each of tax years 2009-11. Respondent obtained petitioner’s sales records from

MGM Grand for the tax years at issue.2 These records were already broken down

      2
        At trial and on brief respondent introduced a method of determining
petitioner’s income adjusted from the one that was used to generate the notice of
                                                                      (continued...)
                                        -7-

[*7] into three roughly yearlong segments that corresponded with the tax years at

issue. These segments were: December 15, 2008, to December 27, 2009 (for tax

year 2009), December 28, 2009, to December 26, 2010 (for tax year 2010), and

December 27, 2010, to December 25, 2011 (for tax year 2011). For the segment

that corresponded to tax year 2009, respondent divided the data by 377 (the

number of days of the segment) and then multiplied the result by 365 to account

for the discrepancy between the segment length and the calendar year.

Respondent did not make this adjustment for either 2010 or 2011 as those

segments more closely represented a 365-day year.

      From the adjusted 2009 data and the original 2010 and 2011 data,

respondent extracted three figures for each year: (1) petitioner’s total charged

sales, which included both credit card and room charge sales; (2) petitioner’s total

noncharged sales, which included both drinks purchased at full price in cash and

all comped drinks; and (3) petitioner’s charged tips generated by the charged sales.

      Using the ratio of charged sales to charged tips respondent determined a

“charge tip rate” for each tax year. To be conservative, respondent then reduced

      2
       (...continued)
deficiency. The adjusted method resulted in assigning petitioner less tip income.
Respondent conceded the difference between the amount determined using the
adjusted method and the amount determined using the original method from the
notice of deficiency.
                                         -8-

[*8] the charge tip rate by 2% to arrive at the “noncharged tip rate” for each year.

Respondent then reduced petitioner’s total noncharged sales by a stiff rate of 15%,

representing the frequency with which respondent estimated that customers did not

leave any tip or “stiffed” petitioner. Respondent then applied the corresponding

noncharged tip rate to petitioner’s adjusted noncharged sales for each year in order

to arrive at petitioner’s total noncharged tip income. Respondent then added the

total noncharged tip income to the total charged tip income to arrive at total tip

income for each year. Respondent then reduced the total tip income by 10% to

account for the tip outs petitioner gave to the barbacks at the end of each shift.

Finally, from this reduced total tip income for each year, respondent subtracted the

amount of tip income that petitioner had reported on his respective tax returns.

After all of the adjustments and calculations respondent determined that petitioner

had underreported his tip income by $19,729, $19,000, and $20,284 for tax years

2009-11, respectively.3




      3
        These amounts reflect concessions that respondent made after the revised
calculations which (1) adjusted the data for 2009, (2) increased the stiff rate from
5% to 15%, (3) applied the stiff rate to noncharged sales (which included cash
sales and all comps) only instead of total sales, and (4) reduced respondent’s total
tip income calculation by 10% to represent the amounts paid to the barbacks
instead of reducing it only by the amounts petitioner had reported on his tax
returns.
                                        -9-

[*9]                                 OPINION

       Tips constitute compensation for services and are includable in gross

income under section 61(a). See Catalano v. Commissioner, 81 T.C. 8, 13 (1983),

aff’d without published opinion sub nom. Knoll v. Commissioner, 735 F.2d 1370

(9th Cir. 1984); Meneguzzo v. Commissioner, 43 T.C. 824, 831 (1965); sec. 1.61-

2(a)(1), Income Tax Regs.

       Taxpayers are required to maintain records sufficient for the Commissioner

to determine their correct tax liability. Sec. 6001; Meneguzzo v. Commissioner,

43 T.C. at 831-832. When a taxpayer receives tips daily, he or she is required to

keep an accurate and contemporaneous record of such income. Ross v.

Commissioner, T.C. Memo. 1989-682, aff’d without published opinion, 967 F.2d

590 (9th Cir. 1992); Biddle v. Commissioner, T.C. Memo. 1989-397; sec. 1.6001-

1(a), Income Tax Regs.; sec. 31.6053-4, Employment Tax Regs. Such records

must be retained by the taxpayer “so long as the contents thereof may become

material in the administration of any internal revenue law”. Sec. 1.6001-1(e),

Income Tax Regs.

       When a taxpayer fails to keep records, or maintains only incomplete or

inadequate records of income, or when a taxpayer’s records are no longer

available, the Commissioner may recompute tips in any manner that clearly
                                       - 10 -

[*10] reflects income. Sec. 446; Meneguzzo v. Commissioner, 43 T.C. at 831.

The Commissioner has great latitude in adopting a suitable method for

reconstructing the taxpayer’s income. Giddio v. Commissioner, 54 T.C. 1530,

1533 (1970). The amount of income determined by the Commissioner need not be

exact so long as it is based on a reasonable methodology in the light of all

surrounding facts and circumstances. Schroeder v. Commissioner, 40 T.C. 30, 33

(1963). The use of a formula based upon the net sales of an employee in the

restaurant or bar industry is a well-established indirect method for computing tip

income. See Cracchiola v. Commissioner, 643 F.2d 1383, 1384-1385 (9th Cir.

1981), aff’g per curiam T.C. Memo. 1979-3; McQuatters v. Commissioner, T.C.

Memo. 1973-240.

      Respondent’s method of recomputing income carries with it the

presumption of correctness, and petitioner has the burden of proving it wrong. See

Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933). The U.S. Court of

Appeals for the Ninth Circuit, to which an appeal in this case would lie, see sec.

7482(b)(1)(A), has held that for the presumption of correctness to attach to the

notice of deficiency in unreported income cases such as this, the Commissioner

must establish “some evidentiary foundation” connecting the taxpayer with the

income-producing activity or demonstrating that the taxpayer actually received
                                        - 11 -

[*11] unreported income, see Weimerskirch v. Commissioner, 596 F.2d 358, 361-

362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977); see also Edwards v. Commissioner,

680 F.2d 1268, 1270-1271 (9th Cir. 1982) (holding that the Commissioner’s

assertion of a deficiency is presumptively correct once some substantive evidence

is introduced demonstrating that the taxpayer received unreported income). If the

Commissioner introduces some evidence that the taxpayer received unreported

income, the burden shifts to the taxpayer, who must establish by a preponderance

of the evidence that the deficiency was arbitrary or erroneous. See Hardy v.

Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), aff’g T.C. Memo. 1997-97.

      Petitioner was employed as a bartender at the MGM Grand during the years

at issue. Respondent introduced records from MGM Grand’s payroll department

showing that petitioner received income from his bartending activities. The

burden of proof remains with petitioner. In addition, petitioner does not contend

that section 7491(a) shifts the burden of proof to respondent, nor does the record

establish that petitioner satisfies the section 7491(a)(2) requirements.

      Petitioner argues that he has met his burden because he complied with the

recordkeeping requirements of section 6001 and section 31.6053-4(a)(1),

Employment Tax Regs., having kept detailed, contemporaneous daily logs which

are substantially accurate. Petitioner routinely recorded the amounts of his cash
                                        - 12 -

[*12] and charge tips on slips of paper at the end of each shift. Petitioner kept

these logs and produced them to respondent and at trial.

      Respondent contends that petitioner’s logs are inadequate for several

reasons. First, respondent points to the fact that the logs were recorded in whole

numbers. Respondent argues that petitioner was not tipped in exact dollar

amounts. Petitioner testified credibly that when he was tipped with change he

would put the change in a glass jar to be mixed in with the other tips. When he

would periodically cash out the change jar, he would give the change to the

cashiers who cashed him out at the end of the shift. He also testified that when he

cashed out daily his charged tips receipt, he would give the cashiers any change

that was generated by those tips. We find petitioner’s explanation credible and do

not find the logs inadequate merely because the amounts are recorded in whole

numbers.

      Second, respondent argues that the daily tip logs are inadequate because

petitioner did not keep track of how much he actually tipped out the barbacks at

the end of each shift. Petitioner testified credibly that he always tipped the

barbacks between 10% and 20% at the conclusion of each shift. Petitioner

deducted only 10% for the tip outs on his Federal income tax return for each year

at issue. When respondent recalculated petitioner’s tip income, respondent
                                        - 13 -

[*13] allowed petitioner a reduction for tip outs of 10% for each year at issue. See

Brown v. Commissioner T.C. Memo. 1996-310 (recognizing that sharing tips with

coemployees reduces gross income). Although ideally petitioner should have kept

track of these tip out amounts, the fact that he did not do so given the facts and

circumstances does not by itself render his logs inadequate.

      Third, respondent also claims that the logs are inadequate because they

appear to be missing days. However, petitioner credibly testified that he

sometimes took vacations or worked flexible days. To the extent that the log days

do not match up with the days from the MGM Grand’s records, petitioner also

testified that frequently the time system would be down or faulty and cause

disparities between his records and those that MGM Grand provided. We find

petitioner’s explanation to be credible and do not find his logbooks to be

inadequate on that ground.

      Finally, respondent contends that petitioner’s logs are inadequate because

they do not precisely match up with the information in his Forms W-2. For 2009

petitioner’s log was off by $3,739. For 2010 it was off by $271. For 2011 it was

off by $1,024. At trial respondent acknowledged that for 2010 the mismatch could

be due to timing differences as the Form W-2 is generated on the basis of pay

periods which do not correspond precisely to the calendar year. Although the
                                        - 14 -

[*14] discrepancies for 2009 and 2011 are larger, they can also be partially

reconciled by the pay period difference. Petitioner testified and submitted

evidence that the MGM Grand time system that tracked tips had malfunctioned

several times throughout the tax years at issue. Petitioner testified that these

malfunctions could be responsible for his reported tips’ being shifted between pay

periods or possibly lost. Given petitioner’s habitual careful recordkeeping, we

find that his logs are a substantially accurate account of his tip income for the tax

years at issue.

      Additionally, petitioner presented evidence of his income and testified

credibly about how he kept track of his tips. Petitioner was an experienced

bartender, and he understood that if he did not participate in the GITCA program

he would be required to keep daily records of his tips.

      Petitioner testified about how his bar was set up and what a shift was like

during the years at issue. He stated that his bar had only six stools and that

customers would often sit at the stools playing poker for several hours and receive

several comped drinks as a result. He testified that the only time his bar would be

busy was when there was a big convention and then most of the drink sales tips

would be on company credit cards rather than cash. He described the difficult
                                        - 15 -

[*15] economic times that Las Vegas faced during the years at issue and how his

business had decreased as a result.

      Petitioner also testified about the typical tipping behavior of his patrons.

Most of his drinks served were comps, and he testified that customers rarely tipped

on comp drinks and that if they did they might “throw [him] a buck or two” after

several hours of sitting at his bar receiving the comped drinks. Petitioner

additionally testified that college kids and foreigners rarely tipped.

      This Court has held that the Commissioner’s method of reconstructing

taxpayers’ tip income is reasonable. See McQuatters v. Commissioner, T.C.

Memo. 1973-240. However, we find that in this case this method does not reflect

petitioner’s income as accurately as petitioner’s own daily records. See Krause v.

Commissioner, T.C. Memo. 1992-270. There is no evidence of a discrepancy in

petitioner’s records that would result in the unreported income showed by

respondent’s calculations.

      On the basis of all the evidence presented, and on this record, we find that

petitioner has met his burden of proof. He has satisfied the requirement of section

31.6053-4(a)(1), Employment Tax Regs., by keeping a daily record and has

reported amounts substantially the same as recorded therein. We find petitioner’s
                                        - 16 -

[*16] figures accurately reflect the tip income he earned during the years at issue.

See Krause v. Commissioner, T.C. Memo. 1992-270.

      We find that petitioner fully reported his tip income on his 2009, 2010, and

2011 Federal income tax returns. We do not sustain respondent’s deficiency

determinations and therefore need not decide whether accuracy-related penalties

under section 6662(a) would be appropriate.

      Any contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                                 Decision will be entered

                                       for petitioner.
