Tipping Treated as a Regular Wage

Tax Professionals' Resource
January 17, 2014 — 1,613 views  
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As per the latest interim guidance announcement 2012-25 from the Internal Revenue Service, the IRS is regarding the treatment of gratuities or automatic tipping as service charges. The businesses that deal with tips may have to change their reporting systems to be compliant with the revenue ruling. The IRS has also granted an additional amount of time for businesses undergoing certain unique circumstances to make necessary amendments to their practices and introduce necessary changes in the system to facilitate the same.

History and Background

The reporting rules under the employment tax and special income provisions are applicable to the tips the employees receive in the service industry. As per the Sections 3121(a) and 3121(q) of IRS code, any cash tips an employee receives would be considered as wages for tax purposes, and as a result will be required to be reported to the employer by all employees who receive either directly or indirectly cash tips and also tips through credit as well as debit cards that exceed $20 a month under the section 6053. The employers are in turn required to collect the social Security tax, Income tax, and Medicare tax on all the tips that are reported by the employee. The employees are required to make use of the Form 4070 to report to their employers about the amount of tips they receive on or before the 10th day of the succeeding month.

There are several risks associated with the accurate reporting of the tips earned by employees. To help the employers in this situation the IRS has established several voluntary compliance programs to help reduce any form of audit risk related to an incident of under reporting of tips. However, in case of service charges collected and distributed by the employer to the employees, all normal reporting rules are applicable without any concessions. These service charges would also be considered as wages.

Service Charges and Examination of Tips

When examining the tips in any particular organization, it is very important that the service charges distributed include any compensation for automatic tipping as described by the Revenue Ruling--and that these would be categorized as wages and not tips. Service charges should not be calculated in any hourly rate or other mechanisms to determine the rate. In the past, IRS examiners would generally attribute the income generated through service charges to automatic tipping. As per the new guidelines, the existing tip compliance agreements need to be amended to correctly attribute distributed services charges as tips.

Date of Implementation and Necessary Action

The Revenue Ruling would be effective immediately and is also applicable retroactively. But, since there may be some businesses that may have to change their manual or automated reporting system to comply with the appropriate treatment of all services charges as per the new regulations, an interim guidance has been established by the IRS to provide special provisions under certain limited circumstances. The IRS examiners would be responsible to identify whether these provisions should be applicable to a particular business based on certain facts and circumstances that allow them to decide if the business requires additional time to amend its practices.

Tax Professionals' Resource