Originally published on Passive Activities and Other Oxymorons on April 4th, 2011.
As I noted in my post From Mercenaries to Mothers Milk, tax issues enter into all aspects of life. My blogs mission statement "providing a slightly quirky look at current tax developments" causes me to be driven to some extent by the raw material that the system feeds me. So here I find myself once again touching on issues that are less than edifying.
In many major metropolitan areas and even in less than major areas there are business establishments where men go to look at women who are less than fully clothed. With an incredible sense of irony these establishments sometimes characterize themselves as "gentlemen's clubs". In Worcester county, to my knowledge, having heard about them from people who have spoken to people who have actually frequented them, there are at least six such establishments. They are actually not that hard to find and some even have websites.
I once saw a movie, I think it was on the Lifetime Channel, about a sex addict. Checking into a hotel, he says to the desk clerk that he would like to go for a walk but he is unfamiliar with the city and asks if there are any neighborhoods nearby he should avoid. That was clever. Apparently in some cities, he could just hale a cab and get expert advice from the cab driver on where to go and a ride there to boot. It turns out that cab drivers who provide this type of counsel to their passengers are not bound by standards of independence. They frequently receive consideration from the establishments for delivering clients to them. It turns out that this can be a fairly complex affair:
Some adult entertainment clubs (and other establishments) have a practice of making payments to taxicab drivers who bring passengers to their establishments. Generally, the club personnel will not render payment to the driver until the passengers first pay a cover charge or otherwise indicate in some manner that they are patrons of the club (such as purchasing drinks or drink tickets). Payments are usually made in cash, although some clubs issue vouchers to the drivers that can be exchanged for cash at a later time. The amount of the cash or voucher payment may or may not bear any relationship to the meter fare, may vary depending upon the number of passengers, and may be far greater than either the metered fare or the customary tip for the transportation. Typically, one or more passengers are transported from a hotel directly to a club. In some cases the driver may make agreements with certain hotel personnel so that when a guest wants to go to a club, the hotel personnel will summon the driver's taxicab from the queue at the hotel and the driver will split the payment from the club with the hotel personnel. In some cases the passenger may not request a particular destination and the driver or hotel personnel will recommend a club that will pay an amount for delivering the passenger/club patron. Several clubs and other establishments advertise in a local magazine, specifically targeted at drivers in the transportation industry, that they will pay a “referral fee” or “tip” or “incentive” for delivery of passengers/patrons.
There are three tax questions:
1. Whether the payments are income to the drivers
2.Whether the payments are tips for services the drivers perform as employees of the taxicab companies (tips in the course of employment) or are payments for separate and distinct services
3. What reporting requirements apply to the payments
The first question is kind of a "Duh", but they do take the trouble to answer it:
I.R.C. § 61(a)(1) provides that gross income means all income from whatever source derived, including (but not limited to) compensation for services, including fees, commissions, fringe benefits and similar items. Treas. Regs. § 1.61-2(a)(1) provides that tips are income to the recipients. The payments made by the clubs to the drivers are income to the drivers regardless of whether the payments are tips or remuneration for services that are separate and distinct from their employment by the taxicab companies.
The second question is a little more interesting. It turns out that the payments are not tips:
The fact that the payments from the clubs are contingent upon the “passenger” becoming a “patron” of the club—whether by entering the club, paying the cover charge, buying a drink, etc.— illustrates that the payment is made for the separate service of delivering a patron rather than transporting a passenger. The club is not the recipient of the transportation service; they are the recipient of the delivery of a patron. Furthermore, the fact that drivers frequently recommend the passenger's destination, sometimes in collaboration with hotel personnel, in order to secure the payment from a particular club further strengthens the conclusion that the clubs are paying the drivers for bringing them customers, a service separate and distinct from merely transporting passengers to the passenger's requested destination.
That brings us to the third question. It turns out that the "establishments" should be sending 1099's to any of the drivers that receive more than $600 :
Because the payments at issue are for separate and distinct services of delivering patrons to the clubs, the clubs are required under I.R.C. § 6041 to file a Form 1099 with the IRS for each taxicab driver to whom they paid $600 or more during the calendar year. 6 If the clubs do not file Form 1099, whether they are subject to penalties under I.R.C. § 6721 depends on the facts and circumstances.
It seems like the Chief Counsel folks are not getting too excited about taking this project on:
While the facts you have collectively presented warrant the conclusion in this memorandum that the payments at issue are for services separate and apart from the drivers' employment, we note that an examination of a specific club or of a specific driver may produce different or varied facts, including indications that the cab companies receive part of the payments, that may or may not warrant the same conclusion or may present a differing degree of uncertainty regarding the proper characterization of the payments, thereby increasing the hazards of litigation. ——————-——————————————————————————————————————————————————————————-———————— ——————————————————————————————————————————————————-——————————————-
In addition, while published guidance and some case law provide helpful analysis in characterizing the payments at issue, we have found no prior cases or other authority which definitively defines tips in the context of the facts and circumstances described. Accordingly, the legal issue would be somewhat novel in litigation. ——————————————————————————————————————————————————————————-—————————————— ————————————————————————————————————————————-———————————————————————————— ——————————————————————————————-——————————————————————————————— ——————————————————————————————————————————————————————————-—————————————— —————————————————————————————
The blank lines are the portions of the memo that are exempt from disclosure under the Freedom of Information Act. I can't help but wonder if they are discussing the surveillance techniques that they would have to use in order to build cases in this area