When the IRS lawyer has to spend 20 of her alloted 30 minutes trying (and apparently failing) to answer the same question repeated by 7 of the 9 justices, I'd say the IRS case is pretty much down the toilet.
The IRS decided to audit a restaurant to figure out if the restaurant had paid the proper amount of Social security and medicare tax on behalf of its employees. (Tips have to be included in the wages for purposes of this calculation.) Employees are supposed to report tip income to the restaurant so that taxes can be withheld. Here it seems quite likely that the employees underreported tips to the employer:
Fior d’Italia reported that in 1991 its employees made $247,181 in tips, and in 1992 they earned $220,845. The charge slips alone for 1991 showed $364,786 worth of tips given, and in 1992 the forms showed $338,161. This indicated to the IRS that roughly $150,000 worth of tips was not reported for each of these years in charges alone, not to mention any possible cash tips. The IRS figured that the charge slips revealed a 14.49 percent tip rate for 1991 and a 14.29 percent tip rate for 1992.
The IRS then applied these tip rates to the restaurants total sales to determine what the total tips should have been. Because this was more than the amount the restaurant had reported, the IRS assessed back taxes.
The lower courts decided that the IRS was not authorized to estimate the taxes owed by the restaurant in this manner. The story talked about the performance of the government attorney who was trying to get the Supreme Court to reverse the Ninth Circuit. Her methods were not very likely to be effective.