MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT, Judge: Respondent determined deficiencies in Federal individual income tax against petitioner for 1974 and 1975 in the amount of $ 2,630 and $ 3,848, respectively, and additions to tax under section 6653(a)1 (negligence) for 1974 and 1975 in the amounts of $ 132 and $ 192, respectively. After concessions by respondent, the issues for decision are as follows: 2
(1) Whether petitioner understated his tip income and, if so, by how much; and
(2) Whether petitioner is liable for additions to tax under section 6653(a).
FINDINGS OF FACT
Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.
When the petition in this case was filed, petitioner resided in Las Vegas, Nevada.
During the last eight months of 1974 and all of 1975, petitioner worked as a full-time waiter in the Ziegfield Room at the MGM Grand Hotel (hereinafter sometimes referred to as "the MGM"), a casino-hotel in Las Vegas.
Petitioner was paid for numbers of hours (excluding vacation and sick leave but including overtime hours actually worked) relative to his work as a waiter as shown in table 1.
Table 1
| 1974 | 1975 |
| Ziegfield Room | 1,380 | 1,991 |
| Other work | 260 | 0 |
The Ziegfield Room first opened on April 23, 1974. During 1974 and 1975, it was the production showroom in the MGM, and its only entertainment feature was the stage show, "Hallelujah Hollywood". There were two shows nightly, except that starting in March 1975 there were three shows nightly on Saturdays.
Only drinks were served in the Ziegfield Room (i.e., there were no dinner shows). During 1974 and 1975 there was a four-drink minimum charege of $ 15 (plus 13 1/2 percent taxes) per person. In the Ziegfield Room, waiters and waitresses (hereinafter referred to as "servers") set up the service areas, took drink orders, served drinks, and presented checks; they were assisted by busboys whose function was to supply and help clear the service areas. The Ziegfield Room's service areas were divided into 35 stations. Each server covered a single station by himself or herself. The stations (except station 35) had a varying capacity to serve from 28 to 44 patrons. The Ziegfield Room had a stated capacity of 860 patrons; 3 however, in 1974 and 1975 the Ziegfield Room was operating in excess of stated capacity on a consistent basis. Servers rotated on assignment through the 35 stations on a daily basis; at the end of each rotation a server "floated" for two weeks, during which time he or she was assigned to different stations to substitute for sick or vacationing servers. Rotation and assignments were generally made on an equitable and uniform basis.
Servers received hourly wages from the MGM and tips from the Ziegfield Room's patrons. Servers did not pool their tips.
Tips were received in cash, and on credit card sales, room charges, and contract (or "coupon") sales. None of these tips were included on a server's Forms W-2 unless the tips were declared to the MGM by the server.
Cash tips were received directly from the patron when the patron paid the bill and left a cash tip for the server; charge patrons might also tip in cash. If a credit card patron wrote a tip on the credit slip, the server prepared a "tip payment slip", which was taken to the cashier and redeemed for cash upon receipt or at the end of the shift. If a room charge patron added a tip to the bill, the server also prepared a "tip payment slip".
Contract sales were sales from individual or group tour packages. Such packages generally included the cost of room, show, and four drinks for a single price, including taxes and tips. The tips included in the single price were fifteen percent of the price of the show, excluding taxes. On the show, the applicable taxes were a sales tax of 3.5 percent and an entertainment tax of ten percent of the price of the show, excluding tips. Thus, the tips on contract sales amounted to approximately 13.2 percent of the price of the show, including taxes. A customer who purchased the package was given a coupon book containing show and drink coupons; these coupons were used by the customer to pay the bill for the show. The server redeemed the coupons through the bashier and received the fixed tip.
Employment in the Ziegfield Room was generally obtained on the basis of seniority, turnover rates were low, and the job offered security.
Some minor problems attributable to initial operations occurred in the Ziegfield Room, but petitioner had no continuing problems, and was not below average, with respect to his work as a server.
Table 2 reflects information with respect to the Ziegfield Room.
Table 2
| 1974 | 1975 |
| Paid hours of work by servers | 74,852 | 102,308 |
| Total sales, including taxes | $ 7,946,466.71 | $ 13,130,212.61 |
| Adjusted total sales (total |
| sales less excess of minimum |
| charge over beverage sales) | $ 6,106,838.00 | $ 10,751,051.00 |
| Tips paid out by the MGM on |
| tip payment slips from credit |
| card sales, room charges, and |
| contract sales | $ 245,552.87 | $ 398,075.00 |
| Tips declared to the MGM by |
| servers | $ 157,294.60 | $ 261,526.29 |
For the notice of deficiency, respondent determined petitioner's tip income on the basis of a formula derived from the MGM books and records of the Ziegfield Room and from certain assumptions by respondent. Respondent obtained information as to sales in the Ziegfield Room during 35 days in 1974 and 12 days in 1975 that were charged on Master Charge, American Express, and room charges. Charge sales that reflected no tip charged were excluded from the sample. The days to be used in the charge sales analysis for 1974 were ascertained through the use of a statistical technique known as a stratified random sample; such a technique is commonly used and its application in this case increases the likelihood that variance due to differences in data attributable to daily or seasonal variations were accounted for. The fact that in 1974 only 35 days were sampled (on account of the nonexistence of the Ziegfield Room before April 23, 1974), whereas 52 days were recommended to be sampled for a full year, does not significantly alter or adversely affect the sample. The use of 12 days in the charge sales analysis for 1975 is statistically adequate, since it was designed merely to supplement a base year analysis.
Respondent determined petitioner's tip income from the Ziegfield Room as shown in table 3. 4
Table 3
| April 23, 1974 |
| through |
| December 31, 1974 | 1975 |
| A. Tip percentage computation |
| 1. Charge sales analyzed |
| (including taxes) | $ 139,218.50 | $ 64,802 |
| 2. Tips charged on these sales | $ 21,548.01 | $ 8,423 |
| 3. Tip percentage (A2./. A1) | 15% | 13% |
| B. Tips per hour computation |
| 1. Adjusted total sales |
| (see table 2) | $ 6,106,838 | $ 10,751,051 |
| 2. Less 15% stiff and 5% |
| other (20%) | $ (1,221,368) | $ (2,150,210) |
| 3. Adjusted net sales (B2 - B1) | $ 4,885,470 | $ 8,600,841 |
| 4. Gross tips (B3 X A3) | $ 732,821 | $ 1,118,109 |
| 5. Less: 16.67% (tips given to |
| busboys, bartenders, etc.) | $ (122,161) | $ (186,389) |
| 6. Adjusted tips (B4 - B5) | $ 610,660 | $ 931,720 |
| 7. Paid hours of work by |
| servers (see table 2) | 74,852 | 102,308 |
| 8. Tip rate per hour (B6./. B7) | $ 8.16 | $ 9.11 |
| C. Petitioner's tip income |
| 1. Paid hours of work (see note 4) | 1,380 | 1,991 |
| 2. Tip income (B8 X C1) | $ 11,260.80 | $ 18,138.01 |
On his Federal income tax return for 1974, petitioner reported as compensation from the MGM the $ 7,848.32 shown on his Form W-2 for this year. Of this amount, $ 3,626 is tip income declared to his employer and the remaining $ 4,222.32 is other compensation. All of the $ 3,626 tip income is attributable to petitioner's work in the Ziegfield Room. Of the $ 4,222.32 other compensation, $ 3,384.70 is attributable to petitioner's work in the Ziegfield Room.
On his Federal income tax return for 1975, petitioner reported as compensation from the MGM the $ 11,274.08 shown on his Form W-2 for this year. Of this amount, $ 5,840.00 is tip income declared to his employer and the remaining $ 5,434.08 is other compensation.
Under the MGM's system of accounting for declared tips, a server's tips received in December of one year would appear as declared tips on the server's Form W-2 for the next year. As a result of this practice, $ 450 of petitioner's declared 1974 tips were included on petitioner's 1975 Form W-2 and not on his 1974 Form W-2; also $ 505 of petitioner's declared 1975 tips were included in petitioner's 1976 income and not on his 1975 Form W-2.
Petitioner maintained a tip diary for 1974 and 1975 relative to his employment in the Ziegfield Room. The amounts shown on the diary match the amounts petitioner declared to the MGM, with the December adjustments noted above, and with the exception of $ 640 (for November 1975) which was never declared.
Petitioner's diary shows no entry before May 6, 1974, although he evidently worked about 70 hours in the Ziegfield Room before that date.
Petitioner's diary showed 1974 tips averaging $ 2.95 per hour ($ 4,076./. 1,380 hours). Petitioner reported on his 1974 Federal income tax return tips averaging $ 2.63 per hour. In 1974, the amounts the MGM paid out on tip payment slips averaged $ 3.28 per hour (see table 2, supra).
Petitioner's diary showed 1974 tips averaging $ 3.28 per hour ($ 6,535./. 1,991 hours). Petitioner reported on his 1975 Federal income tax return tips averaging $ 2.93 per hour. In 1975, the amounts the MGM paid out on tip payment slips averaged $ 3.89 per hour (see table 2, supra).
The average tip rate per hour for the Ziegfield Room (corresponding to line B8 in table 3) was $ 7.34 for 1974 and $ 8.51 for 1975.
OPINION
1. Tip Income
Petitioner reported on his Federal income tax returns, and respondent determined, the amounts of tip income shown in table 4.
Table 4
| 1974 | 1975 |
| Petitioner reported | $ 3,626.00 | $ 5,840.00 |
| Respondent determined | 5 $ 11,260.80 | $ 18,138.01 |
Petitioner maintains that he did not earn the additional tip income determined by respondent. Respondent asserts that petitioner's tip income was not less than the amounts determined by him. Respondent's approach appears to be reasonable; nevertheless, we are persuaded, on the basis of the record herein, that some adjustment to respondent's computation of tip income is necessary.
Tips are, of course, includible in gross income under section 61(a), 6 e.g., Olk v. United States,536 F.2d 876, 879 (CA9 1976); Schroeder v. Commissioner,40 T.C. 30, 33 (1963). If a taxpayer fails to keep records or the records kept do not clearly reflect income, then respondent may reconstruct the taxpayer's income by use of a formula. See Mendelson v. Commissioner,305 F.2d 519 (CA7 1962), affg. a Memorandum Opinion of this Court; 7Meneguzzo v. Commissioner,43 T.C. 824 (1965); Sutherland v. Commissioner,32 T.C. 862 (1959). It is, however, open to petitioner to point out areas or specific instances in which the method used by respondent failed to reflect his true income. Meneguzzo v. Commissioner,43 T.C. at 835.
Respondent, on the basis of his statistical analysis, has determined that gross tips in the Ziegfield Room averaged twelve percent of sales, including taxes, for 1974 (15 percent based on the charge slip sample, minus 20 percent of this amount for "stiffs and other adverse factors") and 10.4 percent of sales for 1975 (13 percent minus 20 percent of this amount).
If the charge slip sample was adequate, the average server grossed fifteen percent and thirteen percent for 1974 and 1975, respectively, on the charge slip sales where tips were also charged. MGM's method of computing tips on contract sales (15 percent of sales before taxes), results in each server having grossed about 13.2 percent of sales price, including taxes, on these sales.
Since the latter categories of sales involved higher average tips than the overall average (after "stiffs", etc.) assumed by respondent, respondent's method of estimating tip income as to the Ziegfield Room necessarily assumes a substantially lower average gross tip rate on cash sales, and on room charges and charge slip sales where no tip was recorded on the charge slip.
Respondent determined that gross tips should be further reduced by one-sixth in order to take into account sharing of tips with busboys and bartenders. This determination is consistent with the parties' stipulations in the instant case.
We conclude that respondent's method of determining average tip income in the instant case is reasonable. However, respondent's sampling leaves some small margin for error. In addition, we are persuaded that some greater allowance must be made for "stiffs", etc., than respondent was willing to allow. Doing the best we could with the record before us, and taking into account petitioner's lack of adequate records, we have found that the average tip rate per hour for the Ziegfield Room was $ 7.34 for 1974 and $ 8.51 for 1975.
Petitioner has failed to show that he received less tip income than the average server in the Ziegfield Room during 1974 and 1975. Indeed, what evidence there is in the record on this point tends to support the conclusion that petitioner received as much tip income as the average Ziegfield Room server.
Petitioner objects to the inclusion of taxes in the formula, arguing that customers do not compute tips on taxes. Although this may be true, removal of taxes from line B1 in table 3 would require removal of taxes from line A1 in this table; the tip percentage (line A3) would thereby increase and the tip rate per hour (line B8) and tip income (line C2) would remain the same.
Petitioner objects to respondent's assumptions as to "stiff" rate and tips paid to busboys, etc. The adjustments we have made are all that are justified by the record in the instant case.
Petitioner objects to respondent's assumptions as to "stiff" rate and tips paid to busboys, etc., but points to nothing in the record that would allow us to make a better estimate.
Petitioner objects to the use of sampling in the charge sales analysis, asserting that every charge sale should have been analyzed, but offered no evidence to rebut the testimony of respondent's statistician who explained the commonly accepted technique of stratified random sampling and testified as to the degree of reliability that may be expected from such sampling techniques.
Petitioner maintains that we should accept his tip diary as an accurate record of his tip income. The diary showed petitioner's tip income to be less than what the MGM paid out to the average server on tip payment slips. In other words, for the diary to be acceptable as reasonably accurate, we would have to conclude either that petitioner received no cash tips at all or that petitioner was a far poorer server than his colleagues. We find no basis for either conclusion on the record in the instant case.
On this issue we hold that petitioner's tip income is to be determined on the basis of Ziegfield Room tip rates per hour of $ 7.34 for 1974 and $ 8.51 for 1975.
2. Additions to Tax
Petitioner has the burden of proving error in respondent's determination that additions to tax should be imposed under section 6653(a). 8Bixby v. Commissioner,58 T.C. 757, 791-792 (1972).
Petitioner has failed to prove that properly maintained records of tip income would have shown his 1974 and 1975 tip income to be only the relatively small amounts he reported. Petitioner has failed to prove that his lack of proper records was not due to negligence. We conclude that section 6653(a) applies.
On this issue we hold for respondent.
To reflect the conclusions reached herein, and respondent's concessions,
Decision will be entered under Rule 155.