4.23.7  Employment Tax on Tip Income

Manual Transmittal

January 13, 2014

Purpose

(1) This transmits revised IRM 4.23.7, Employment Tax, Employment Tax on Tip Income.

Background

Updates and revisions are made to this section for procedural and technical changes.

Material Changes

(1) Editorial, typographical, and technical changes have been made throughout the section.

(2) IRM 4.23.7.1(2). Modified statement to read "All policy and procedures for tip examinations and tip agreements, regardless of operating division, should be coordinated through the SB/SE, Headquarters Employment Tax Policy Office."

(3) IRM 4.23.7.2(5). Added information on the additional Medicare tax.

(4) IRM 4.23.7.4. Added information on the additional Medicare tax and Form 8959.

(5) IRM 4.23.7.5.2(2) and (3). Added information on Form 8959 and additional Medicare tax.

(6) IRM 4.23.7.6.2(5). Added examples of employer policy driven service charges.

(7) IRM 4.23.7.6.3. New subsection Prospective Treatment of Revenue Ruling 2012-18, Tips vs. Service Charges, incorporating Interim Guidance Memorandum SBSE-04-0113-0005, issued January 22, 2013, Interim Guidance on Tips vs. Service Charges Revenue Ruling 2012-18. Includes additional instructions and guidance links.

(8) IRM 4.23.7.7.3(1). Added paragraph to reference new Exhibit 4.23.7-2, Chart of Tip Report Writing Instructions.

(9) IRM 4.23.7.8(1)(a). Added information on Additional Medicare Tax for Form 872 completion.

(10) IRM 4.23.7.8.1(1). Added information on Additional Medicare Tax and Form 8959.

(11) IRM 4.23.7.8.1(2). Reworded, and list eliminated.

(12) IRM 4.23.7.9(1). Added Note with information on Additional Medicare Tax for IRC 45B credit.

(13) IRM 4.23.7.9(2). Added TAM 201347020 as example of an entity not eligible as a IRC 3401(d)(1) employer.

(14) IRM 4.23.7.10.6.5. Removed reference to obsolete IRM 4.70.

(15) Exhibit 4.23.7-1. Removed Suspense Code narrative and chart, as suspense codes are not necessary to control gaming agreements on ERCS.

(16) Exhibit 4.23.7-2. New exhibit ,Chart of Tip Report Writing Instructions, added.

Effect on Other Documents

This material supersedes IRM 4.23.7, dated December 18, 2012. This section incorporates Interim Guidance Memorandum SBSE-04-0113-0005 (also identified as SBSE-04-0113-005), issued January 22, 2013, Interim Guidance on Tips vs. Service Charges Revenue Ruling 2012-18.

Audience

This section contains instructions and guidelines for all LB&I, TE/GE, and SB/SE employees when dealing with employment tax tip issues.

Effective Date

(01-13-2014)

John H. Imhoff, Jr.
Director, Specialty Programs
Small Business/Self-Employed Division

4.23.7.1  (01-13-2014)
Overview

  1. This section provides procedures for employment taxes on tip income.

  2. All policy and procedures for tip examinations and tip agreements, regardless of operating division, should be coordinated through the SB/SE, Headquarters Employment Tax Policy Office. This office has service-wide responsibility for oversight and policy decisions regarding tip examinations and the Tip Rate Determination and Education Program.

  3. Tips are considered wages for purposes of the Federal Insurance Contributions Act (FICA), and federal income tax withholding for cash tips of $20.00 or more received in any calendar month. Cash tips include tips received from customers, charged tips (for example, credit and debit card charges) distributed to employees by employer, and tips received from other employees under any tip-sharing arrangement. Both directly and indirectly tipped employees must report tips received to their employer. Tips are subject to various reporting requirements for both the employee and the employer.

  4. For Federal Unemployment Tax Act (FUTA) tax purposes, IRC 3306(s) provides that the term "wages" includes tips which are:

    1. Received while performing services which constitute employment, and

    2. Included in a written statement furnished to the employer pursuant to IRC 6053(a).

4.23.7.2  (01-13-2014)
Introduction

  1. Under Treas. Reg. 31.3102–3, the employer is responsible for deducting and depositing the employee's share of social security and Medicare tax on tips. All tips should be included in a written report furnished by the employee to the employer. The employer must withhold to the extent that collection can be made from the employee's funds on or after the time the written statement is furnished. The employee's funds include wages (exclusive of tips) in the employer's possession and amounts turned over to the employer by the employee.

  2. If the employee does not provide enough money, the employer will apply the employee's regular pay and any money the employee gives to the employer to the taxes in the following order:

    1. Social security and Medicare or railroad retirement taxes on the employee's regular wages,

    2. Federal, state, and local income taxes on the employee's regular wages,

    3. Social security and Medicare taxes or railroad retirement taxes on the employee's reported tips, and

    4. Federal, state, and local income taxes on the employee's reported tips.


    Any taxes that remain unpaid can be collected by the employer from the employee's next paycheck. If withholding taxes remain uncollected at the end of the year, the employee may be subject to a penalty for underpayment of estimated taxes.

  3. IRC 3121(q) provides that employers must pay the employer's share of social security and Medicare taxes on tips reported by their employees in the course of employment. The tips are deemed to have been paid at a time a written statement including such tips is furnished by the employee to the employer. If no such statement is furnished (or to the extent the statement is incomplete or inaccurate) the tips will be deemed to be paid on the date on which Section 3121(q) Notice and Demand for the taxes is made to the employer. (See IRM 4.23.7.7.4, Section 3121(q) Notice and Demand Procedures below).

  4. For income tax purposes, tips are wages that are deemed paid at the time a written statement including such tips is furnished to the employer pursuant to IRC 6053(a) or, if no statement including such tips is so furnished, at the time received. Employers are required to withhold federal income tax on tips listed on the employee's written statement.

  5. The employer is required to furnish a statement to the employee showing the amount of social security and Medicare taxes that could not be collected from the employee's wages. Form W–2 is the form prescribed for furnishing this statement. Treas. Reg. 31.6053-2(b). Unlike the uncollected portion of the regular (1.45%) Medicare tax, the uncollected Additional Medicare Tax (0.9%) is not reported on Form W-2. The employer shows the uncollected social security tax, Medicare tax, and Additional Medicare Tax as a current period adjustment on the employer’s employment tax return, (e.g., Form 941, Employer’s QUARTERLY Federal Tax Return).

    Note:

    For tax years beginning after December 31, 2012, a 0.9% Additional Medicare Tax applies to Medicare wages, Railroad Retirement Tax Act compensation, and self-employment income over a threshold amount based on the taxpayer’s filing status. For more information on Additional Medicare Tax, go to IRS.gov and enter "Additional Medicare Tax" in the search box.

4.23.7.3  (12-18-2012)
Employee Tip Reporting

  1. IRC 6053(a) requires that the employee provide the written statement of tip income to the employer by the 10th day of the month following employee’s receipt of the tips, if reportable. No particular form is required to be used in reporting tip income. Treas. Reg. 31.6053–1 requires that the form used should be signed by the employee and disclose:

    1. The name, address, and social security number of the employee,

    2. The name and address of the employer,

    3. The total amount of tip income, and

    4. The period for which, and the date on which, the statement is furnished. If the statement is for a calendar month, the month and year should be specified. If the statement is for a period of less than one calendar month, the beginning and ending dates of the period should be shown (for example, Jan. 1 through Jan. 8, 2013).

  2. Employees may use Form 4070, Employee's Report of Tips to Employer, along with Form 4070A, Employee's Daily Record of Tips, for the written statement of tip income. Forms 4070 and 4070A are included in Publication 1244, Employee’s Daily Record of Tips and Report to Employer.

    Note:

    Some employers may require employees to use an employer-provided form.

  3. In lieu of a separate form for tip reporting, Treas. Reg. 31.6053–1(b)(2)(iii) provides that an employer may prescribe regularly used forms (such as time cards) for use by employees in reporting tips. However, the form must meet the requirements of Treas. Reg. 31.6053–1(b)(1)(iii) and (iv) and must contain identifying information which will assure accurate identification of the employee by the employer.

  4. An employer may prescribe regularly used electronic forms for use by employees for reporting tips. If an electronic statement is used, the electronic system must ensure that the information received is the information transmitted by the employee. The system must document all occasions of access that result in the transmission of a tip statement. In addition, the design and operation of the electronic system, including access procedures, must make it reasonably certain that the person accessing the system and transmitting the statement is the employee identified in the statement transmitted. Any electronic statement must include the same information set out above in paragraph (1). An electronic tip statement must be signed by the employee. The electronic signature must identify the employee transmitting the electronic tip statement and must authenticate and verify the transmission. Upon request by the IRS, the employer must supply the IRS with a hard copy of the electronic tip statement and a statement that, to the best of the employer’s knowledge, the electronic tip statement was filed by the named employee. Treas. Reg. 31.6053-1(d).

  5. If an employee does not report all cash tips (see IRM 4.23.7.1(3)) to the employer in a written statement, the employee may be subject to the penalty imposed by IRC 6652, Failure to Report Tips.

  6. The cash tips to which this provision applies include checks and any other monetary media of exchange. Tips received by an employee in any medium other than cash, such as passes, tickets, or other goods or commodities, do not constitute wages for FICA purposes. See Treas. Reg. 31.3121(a)(12)–1).

  7. If an employee fails to maintain records, or if the records kept do not accurately reflect the amount of tip income received, the Service is authorized, under IRC 446(b), to reconstruct income in accordance with any method that in its opinion clearly reflects the amount of tip income received.

  8. The employee is responsible for reporting all tip income on his or her Form 1040. Tip income includes cash tips (see IRM 4.23.7(3) above) and the value of tips not paid in cash, for example passes, tickets, goods, or services. These non-cash tips are not included in the Form W–2 but must be reported for Federal income tax purposes on the employee's Form 1040.

4.23.7.3.1  (01-22-2010)
Railroad Retirement Tax on Tip Income

  1. For employees subject to the Railroad Retirement Tax Act, examiners should include in the explanation of adjustments portion of the audit report the following statement, "Changes to amount of wages subject to railroad retirement tax will be reported to the Railroad Retirement Board."

  2. After completing the examination, prepare a memorandum addressed to:

    Chief Financial Officer
    Railroad Retirement Board
    844 Rush Street North
    Chicago, IL 60611

  3. Attach the memorandum to the Form 3198, Special Handling Notice, and place on outside of case file where it will remain as the file is processed. Enter notation "RRTA Tax on Tips" on line "Other."

  4. This memorandum will include employee's name, social security number, name of railroad employer, and the yearly increases or decreases to amounts subject to railroad retirement tax.

4.23.7.4  (01-13-2014)
Form 4137 Requirements

  1. Form 4137, Social Security and Medicare Tax on Unreported Tip Income, is used by an employee to compute the social security and Medicare tax owed on tips not reported to the employer. Unreported tip income, reported on Form 4137, is carried over to Form 8959, Additional Medicare Tax, which is used by an employee to compute Additional Medicare Tax owed on tips not reported to the employer. Unreported tips may include allocated tips shown on the employee's Form(s) W–2, Box 8, (unless the employee can prove a smaller amount with adequate records). The employee may be subject to a penalty equal to 50 percent of the social security tax, Medicare tax, and Additional Medicare Tax due for failure to report tips to the employer unless reasonable cause exists (IRC 6652(b)). The Form 4137 and Form 8959 are filed with the Form 1040.

4.23.7.4.1  (12-18-2012)
Form 4137 Compliance Program

  1. Form 4137 is designed to be used exclusively by employees to calculate the social security and Medicare taxes on unreported tips. Prior to 2007, Form 4137 was also used by employees to report Form 1099 income that they believed were wages rather than non-employee compensation. Starting with tax year 2007, Form 8919, Uncollected Social Security and Medicare Tax on Wages, is used for that purpose.

  2. Form 4137 shows the individual EIN(s) and the employee's unreported tips for each of the employers for whom the employee worked for during the year. Form 4137 allows the Service to aggregate unreported tips reported on Forms 4137 for each employer. This allows the Service to provide each employer with a Section 3121(q) Notice and Demand for the employer’s share of the applicable FICA due on the tips their employees reported to the IRS but did not report to the employer.

  3. IRC 3121(q) provides the authority for the Service to issue a Section 3121(q) Notice and Demand to an employer for the employer’s share of FICA tax on unreported tips – determined either by tip examination or from Form(s) 4137 filed by employees. Detailed guidance related to the Section 3121(q) Notice and Demand process for tip exams is covered in IRM 4.23.7.7.4, Section 3121(q) Notice and Demand Procedures.

  4. The Form 4137 Compliance Program is designed to determine the total tips shown as unreported on Forms 4137 for each employer and then issue a Section 3121(q) Notice and Demand for the payment of the employer’s share of FICA tax on those tips. This program is administered by the National Tip Reporting Compliance Program (NTRCP) within SB/SE Employment Tax.

  5. The Section 3121(q) Notice and Demand process related to Forms 4137 is not considered an examination. The employer's (taxpayer’s) books and records are not examined. The Section 3121(q) Notice and Demand process is a collection program – collecting the employer’s share of FICA taxes related to unreported tips shown on the Forms 4137 with each respective employer through a current period liability to the employer’s Form 941. No specific format is required for the notice and demand, but the Service has developed correspondence for making the notice and demand.

  6. Each case is established on AIMS using the following codes:

    • Project Code 1034: 4137 Tip Correspondence Contacts

    • Tracking Code 7887: 4137 Leads

  7. Service representatives must use Letter 4520-P, Pre-notice for Employer Share of Tax Based on Form 4137, to provide the employer with advance notice of the IRC 3121(q) FICA tax liability. Generally, the Service will send the employer the pre-notice at least thirty days prior to issuing the Section 3121(q) Notice and Demand to allow the employer sufficient time to gather the necessary funds for making a timely tax deposit.

    Letter 4520-P emphasizes to the employer that if a payroll service is used, the employer should immediately notify the payroll service of the IRC 3121(q) FICA tax liability. The payroll service provider may need time to work with the employer so the necessary payroll deposit can be made timely and thus reduce or eliminate any interest or deposit penalties.

  8. There are three attachments to Letter 4520-P:

    1. Tax calculation worksheet: Summarizes the IRC 3121(q) FICA tax liability due,

    2. Form 4137 detail spreadsheet: Lists information from each of the Form(s) 4137 filed under the employer’s EIN (employer identification number), and

    3. FAQs: Provide guidance for the most commonly asked questions.

    Note:

    It is recommended that Service representatives issue the Section 3121(q) Notice and Demand within the first 60 days of the quarter to give the employer sufficient time to gather the necessary funds to make the tax deposit and to have sufficient time to notify its payroll service, if there is one, to ensure a timely tax deposit.

  9. In general, no sooner than thirty days after sending Letter 4520-P to the employer, the Service will send Letter 4520, Section 3121(q) Notice and Demand. This letter will explain how the employer should report the IRC 3121(q) FICA tax liability to avoid penalties and interest.

  10. There are three attachments to Letter 4520 based on Forms 4137:

    1. Tax calculation worksheet: Summarizes the IRC 3121(q) FICA tax liability,

    2. Form 4137 detail spreadsheet: Lists information from each of the Form(s) 4137 filed under the employer’s EIN (employer identification number), and

    3. FAQs: Provide guidance for the most commonly asked questions.

  11. The employer must report the IRC 3121(q) FICA tax liability on the Form 941 for the quarter corresponding to the date of the Section 3121(q) Notice and Demand. This Form 941 is referred to as the "reporting Form 941." The date of the Section 3121(q) Notice and Demand will be the last business day of the quarter in which the Letter 4520 is issued, not the mailing date of the letter.

  12. If the employer fails to report the IRC 3121(q) FICA tax liability on the reporting Form 941, that quarter will be referred to an employment tax exam group to have a limited scope examination initiated on the missing IRC 3121(q) FICA tax liability. This limited scope exam will address the non-reporting of the IRC 3121(q) FICA tax liability only. The exam group should use the following codes to establish these limited scope exams on AIMS:

    • Project Code 1118: Limited Scope Exam – Unreported IRC 3121(q) Tax

    • Tracking Code 7887:- 4137 Leads

    Note:

    For more information on this Program, contact an NTRCP Analyst.

4.23.7.5  (12-18-2012)
Information Return Reporting

  1. Information reporting is a key component in IRS compliance programs. Information reporting also serves to further several key initiatives in the administration of federal income taxes, such as reducing burdens associated with tax return preparation.

  2. Internal Revenue Code sections 6041 through 6053 and Title 31 of the United States Code require that taxpayers report various types of payments to both the Service and the recipients of the payments. These payments include such items as rent, salaries, wages and income paid in the course of a trade or business, and payments such as dividends, interest, and royalties made to another person.

    1. The term "information return" means any statement, return, form or schedule as described in Treas. Reg. 301.6721-1(g). See IRM 4.10.5.6 for details on information returns.

    2. A key information return for tip examinations is Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, discussed in IRM 4.23.7.5.1.

    3. Employers who file Form 8027 and meet the tip allocation rules must report the allocated tip amounts on the affected tipped employee’s Form W-2. Box 8, for the applicable tax year.

4.23.7.5.1  (12-18-2012)
Form 8027 Requirements

  1. Treas. Reg. 31.6053–3 requires certain large food or beverage establishments to make an information return with respect to tips. The employer is required to file a separate information return for each calendar year in which the employer has employees. The information return will contain the following:

    1. The employer's name, address, and employer identification number

    2. The establishment's name, address, and identification number

    3. The aggregate gross receipts (other than nonallocable receipts) of the establishment from the provision of food or beverages

    4. The aggregate charge receipts (charge receipts with charged tips)

    5. The aggregate of charged tips on those charge receipts

    6. The aggregate of tips reported to the employer by the tipped employees

    7. The aggregate amount the employer is required to report under IRC 6051 with respect to service charges of less than ten percent

  2. Large food or beverage establishments use Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, to make annual reports to the Service on its food or beverage operations receipts and employees' reported tips.

  3. A "large food or beverage operation" is defined as one which normally employs more than ten employees on a typical business day during the preceding calendar year and is an operation in which the tipping of food or beverage employees is customary. See Treas. Reg. 31.6053–3(j)(7).

  4. The phrase "more than ten employees on a typical business day" is defined in Treas. Reg. 31.6053–3(j)(9). This test is met if one-half of the sum of the average number of employee hours worked per business day during the calendar month in which the aggregate gross receipts from food or beverage operations were the greatest plus the average number of employee hours worked per business day during the calendar month in which the aggregate gross receipts from food or beverage operations were the least, is greater than 80 hours. This test includes all employees of a food or beverage operation not only food or beverage employees.

    Note:

    Refer to "Worksheet for Determining Whether To File Form 8027" in the Instructions for Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips for additional information.

  5. A food or beverage employee is an employee who provides services in connection with the provision of food or beverages. Such employees include, but are not limited to; waiters, waitresses, busboys, bartenders, hostesses, maitre d's, dining room captains, wine stewards, cooks, and kitchen help. See Treas. Reg. 31.6053-3(j)(10). Employees who are not food or beverage employees include managers, coat check staff, doormen, and parking attendants.

  6. A separate Form 8027 must be filed for each location under common ownership or control. If the total hours of all locations exceed the 80 hours computation, then each location must file a separate Form 8027. This is true even if the individual locations, when considered separately, would not exceed the 80 hours test.

  7. For information about the requirement to file Forms 8027 electronically if 250 or more forms are required to be filed, see Instructions for Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips and Pub 1239, Specifications for Filing Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, Electronically.

4.23.7.5.2  (01-13-2014)
Form 8027 Allocated Tips

  1. An employer who operates a large food or beverage establishment is required to allocate among tipped employees an amount equal to the excess of eight percent of the gross receipts of such establishment for the payroll period over the aggregate amount of tips reported by employees at such establishment to the employer. See Treas. Reg. 31.6053–3(d).

  2. This results in an allocation of a percentage of gross receipts to tipped employees. The individual allocation is entered as an information item on the employee's Form W–2, Wage and Tax Statement, Box 8. There are no taxes withheld from allocated tips because they were not reported by the employee to the employer in a written statement. Employees must report the allocated tips from their Form(s) W–2, Box 8, on a Form 4137, Social Security and Medicare Tax on Unreported Tip Income, which must be attached to their Form(s) 1040 unless they can establish with adequate records that they received a lesser amount. Employees use Form 4137 to compute their share of social security and Medicare tax on these unreported tips. Employees use Form 8959, Additional Medicare Tax, to compute Additional Medicare Tax on these unreported tips. Forms 4137 and 8959 are filed with Form 1040.

  3. The employer is not required to report its share of social security and Medicare taxes on allocated tips because these tips were not reported in a written statement by the employees receiving the allocated tip amounts. However, if unreported tips are determined in the course of a tip audit or through the Form 4137 Compliance Program, the employer is liable for its share of social security and Medicare taxes on the tips that were not reported by employees.

    Note:

    Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax.

  4. Examiners should consider whether to assert any penalties for an employer’s failure to file Form 8027 and/or failure to report tip information on Form W-2 as required. See IRM 20.1.7, Information Return Penalties.

4.23.7.6  (12-18-2012)
Other Information Reporting Issues to Review

  1. In the area of tip income reporting, employers and business owners at times mis-characterize certain payments. Examiners need to be alert for situations where payments for services are inappropriately structured or incorrectly classified. Mis-classification of payments may result in incorrect information return reporting and/or underpayment of employment taxes.

4.23.7.6.1  (12-18-2012)
Payments to Drivers of Taxicabs, Limousines, Tour Buses, and Other Modes of Transportation for Services

  1. Certain payments to drivers of taxicabs, limousines, tour buses, and other modes of transportation may have been mis-characterized by employees, employers, or business owners as tips.

  2. This may occur in situations that involve drivers who are employees of companies engaged in the business of transporting passengers for a fare (e.g., limousines and taxicabs). The drivers pick up and transport passengers to their requested destinations. Typically, the driver collects the fares from the passenger. It is customary for the passenger to tip the driver an amount in addition to the fare for the transportation provided. At issue are other payments the driver may receive in addition to the tips from the passenger.

  3. Some business establishments such as adult entertainment clubs, restaurants, nightclubs, and other service establishments have a practice of making payments to drivers who bring passengers to their establishments.

    1. Generally, the service establishment’s personnel will not render payment to the driver until the passenger first pays a cover charge or otherwise indicates in some manner that they are patrons of the service establishment.

    2. Payments by establishments to drivers are usually made in cash, although some establishments issue vouchers to the drivers that can be exchanged for cash at a later time.

    3. The amount of the cash or voucher payment may or may not bear any relationship to the transportation fare, may vary depending upon the number of patrons, and may be far greater than either the fare or the customary tip for the transportation.

    4. In many situations, one or more passengers are transported from a location such as a hotel directly to the establishment. In some cases, the driver may make agreements with certain hotel personnel so that when a guest wants to go to an establishment (e.g., hotel guest informs hotel personnel that they are interested in finding an adult entertainment club), the hotel personnel will summon the driver with whom they have an agreement from the hotel’s transportation queue and the driver will split the payment from the establishment with the hotel personnel.

    5. In some cases, the passenger may not request a particular destination and the driver or hotel personnel will recommend an establishment that will pay the highest amount for delivering the passenger/patron.

    6. Many establishments advertise in local magazines, specifically targeted at drivers in the transportation industry, The ads indicate that the establishment will pay a "referral fee," "tip," or "incentive" for delivery of passengers/patrons.

  4. Generally, the drivers do not report the payments to their employer as tips. Thus, the employers are not treating the payments as wages subject to employment taxes. The absence of reporting on either Forms 1099 or Forms W-2 may result in some drivers not reporting the payments as income on their income tax returns.

  5. Chief Counsel Advisory (IRS CCA 201106010, dated 12-01-2010), provides that under the facts and circumstances described in the CCA (similar to the situations described above), the payments from the establishments to the drivers are not tips received in the course of employment with the transportation company, but are considered payments for services separate and distinct from those the drivers perform for their transportation company employer. In addition, if the payments to one driver equal or exceed $600 in a calendar year, the business making the payment is required to report these payments on Forms 1099.

  6. When examining service businesses (such as restaurants, night clubs et al.), examiners need to investigate the existence of payments of this type which are usually paid in cash or by a voucher that can be converted to cash at a later date. Various techniques may be used to identify the existence of and deduction for such payments (including observation of drop-off locations of transportation companies at the establishment and inquiries regarding the establishment’s business deductions.)

  7. The reporting requirements applicable to the payments made by the establishments described above are provided in IRC 6041(a). This section requires all persons engaged in a trade or business and making payment in the course of such trade or business to another person of rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable gains, profits, and income of $600 or more in any taxable year, to file an information return with the Service and to furnish an information statement to the payee. Payments are fixed when they are paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained. Treas. Reg. 1.6041-1(c). Payments that are fixed or determinable must be reported on Form 1099. See Treas. Reg. 1.6041-1(a)(2).

  8. If the payments at issue are for the separate and distinct services of delivering patrons, the service establishments are required under IRC 6041 to file a Form 1099 with the IRS for each person (driver) to whom they paid $600 or more during the calendar year. If the establishments do not file Form 1099, examiners should consider assertion of penalties under IRC 6721 and IRC 6722. Penalty assertion should be discussed with the examiner’s manager.

  9. Backup withholding should also be considered if the payor fails to secure a Taxpayer Identification Number (TIN) from the service provider individual (in this case, the driver). The payor is required to back-up withhold a percentage on the payment amount (28% for 2012). If the payor fails to withhold the current applicable backup withholding percentage from the service provider, the payor becomes liable for the backup withholding under IRC 3406. See IRM 4.23.8.13, IRC 3406 - Backup Withholding.

  10. Pub 4904, How to Report Driver Referral Fees, Incentive Payments, and Other Income You Receive, can be used to educate business owners of their reporting, filing, and payment obligations on payments for services.

4.23.7.6.2  (01-13-2014)
Tips vs. Service Charges

  1. Tips are not defined in any IRS code section or regulation. Rev. Rul. 2012-18, 2012-26 I.R.B. 1032, provides criteria for determining whether a payment is a tip or a service charge. Service charges are frequently referred to as "auto-gratuities" in the hospitality industry. Rev. Rul. 2012-18 uses the criteria provided in Rev. Rul. 59-252, 1959 C.B. 215. We rely on Rev. Rul. 2012-18 in making the distinction between a tip and a service charge (or auto-gratuity). Examiners should verify that distributed service charges are properly characterized as wages subject to withholding, and not as tips.

  2. Rev. Rul. 2012-18 provides specific examples of amounts characterized as tips and service charges to illustrate the application of factors relevant to distinguishing a tip vs. a service charge. Example A in Q&A 1 of Rev. Rul. 2012-18 illustrates a service charge paid by a large party when the menu specifies that a fixed charge will be added to all bills for parties of 6 or more customers. Example B illustrates a tip in a situation where the credit card charge receipt shows sample tip calculations.

  3. The incorrect characterization impacts the withholding rules and affects a number of forms and credits:

    • Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips,

    • Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, for the IRC 45B credit, and

    • Form 3800, General Business Credit.

  4. The criteria of Rev. Rul. 2012-18 should be applied to determine whether the payment made is a tip or a service charge. Q&A 1 of Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:

    1. The payment must be made free from compulsion,

    2. The customer must have the unrestricted right to determine the amount,

    3. The payment should not be the subject of negotiation or dictated by employer policy, and

    4. Generally, the customer has the right to determine who receives the payment.

  5. A contractually fixed gratuity for catering, banquets, weddings, transportation, baggage handling and other events or items is generally considered to be service charges if the amount is distributed or paid to the service staff. A non-contractually fixed gratuity, or "auto-gratuity," that is the policy of the employer is generally considered to be a service charge. If these amounts are distributed or paid to the employees, then the amounts are non-tip wages subject to withholding. Examples of employer policy driven service charges:

    1. Employer sets a fixed charge or "auto-gratuity" for all purchases in the food or beverage establishment regardless of amount of sale or number of guests

    2. Auto gratuity added for a large party of customers

    3. Bottle service fees or cork fees in night clubs or restaurants

    4. Delivery fees in the pizza industry or other delivery service industries

  6. Examinations performed in industries where tipping is customary should include the following:

    1. An evaluation of the employer’s policy for customer gratuities,

    2. The internal controls for payments received by the establishment or the employee as gratuities,

    3. The splitting or pooling of gratuities,

    4. The employee’s reporting of gratuities to the employer under IRC 6053(a), and

    5. The distribution of gratuities from the employer to the employees.

  7. The employer’s characterization of a payment as a "tip" is not determinative. The fact that the employee may have reported the payment as a "tip" to the employer is also not determinative. When performing a tip examination, examiners must ensure that distributed service charges are properly characterized as wages subject to withholding and not as tips. Distributed service charges that have been characterized as tips should generally be re-characterized and an adjustment made to the Form 941 under examination and reported on employment tax report Form(s) 4666 and 4668.

  8. Amounts determined to be service charges and not tips are not eligible for the IRC 45B credit claimed on Form 8846, (and thus are not eligible for the General Business Credit claimed on Form 3800.)

  9. When calculating the amount of unreported tips for an employer-only assessment under IRC 3121(q), examiners must ensure they do not include service charges in the Section 3121(q) Notice and Demand.

  10. A review of the correct characterization of service charges does not constitute a "tip examination" within the meaning of a voluntary tip agreement. Establishments possessing a tip agreement can be contacted to review the tip vs. service charge issue. The examiner must take caution against making an adjustment for unreported tips and focus on the correct characterization and reporting of service charges.

  11. A tip rate review of an employer participating in a voluntary tip compliance agreement should also include an evaluation of the items in the preceding paragraph.

    1. Service charges should not be included in any calculation that arrives at an hourly tip rate, tip rate calculated on a percentage of sales, or any other rate determination method when preparing a voluntary tip compliance agreement.

    2. Examiners should note in their work papers and appendices that service charges were not included in the tip rate computations.

    3. The tip agreement should also instruct the employer how to account for and report service charges.

4.23.7.6.3  (01-13-2014)
Prospective Treatment of Revenue Ruling 2012-18, Tips vs. Service Charges

  1. The IRS issued Rev. Rul. 2012-18 to clarify and update guidelines first presented in Rev. Rul. 95-7, 1995-1 C.B. 185, concerning the taxes imposed on tips under the Federal Insurance Contributions Act (FICA) and the notice and demand under section 3121(q) of the Internal Revenue Code (Code). In addition, communications with external stakeholders, examinations of tipped employers, and an increase in the use of "auto-gratuities" by employers that operate in service industries led the IRS to believe additional clarification in this area would be in the best interest of tax administration.

  2. When Revenue Ruling 2012-18 was issued, the IRS also recognized that employers and employees would need some time to adjust their policies and accounting systems to fully comply with the guidance. The IRS therefore issued Announcement 2012-25 to alert employers of the examination policies communicated to IRS compliance personnel. That announcement contained the full text of an Interim Guidance Memorandum (IGM) issued to compliance personnel instructing examiners to apply the guidance of Revenue Ruling 2012-18 prospectively, under very limited facts and circumstances. As was communicated in Announcement 2012-25, examiners, in limited circumstances, may apply the guidance prospectively to amounts paid on or after January 1, 2013. The limited circumstances communicated in the IGM are:

    1. In determining whether Q&A 1 of this revenue ruling should be applied prospectively, examiners should consider whether the set of facts and circumstances at issue was directly addressed in prior guidance and whether the business needs additional time to amend its business practices and make system changes to come into compliance.

    2. Some of the prior guidance which may be applicable includes:
      - Rev. Rul. 57-397, 1957-2 C.B. 628 (where amounts required to be paid to a hotel by customers for using dining facilities included amounts distributed by the hotel to waiters and other employees),
      - Rev. Rul. 59-252, 1959-2 C.B. 215 (where negotiations between a hotel and customer for use of hotel’s banquet facilities included additional amounts for distribution to employees),
      - Rev. Rul. 64-40, 1964-1 C.B. 68 (where a club’s board of governors determined amounts distributed to employees from a fund made up of contributions by club members),
      - Rev. Rul. 66-74, 1966-1 C.B. 229 (where amounts collected by a club through mandatory charges added to members’ bills were distributed to employees), and
      - Rev. Rul. 69-28, 1969-1 C.B. 270 (where five examples of amounts paid to employees are discussed).

  3. If examiners find that the set of facts and circumstances at issue was not directly addressed in prior guidance, then Q&A 1 of Rev. Rul. 2012-18 should be applied prospectively. In this regard, Q&A 1 should be applied prospectively to amounts paid under facts that are substantially the same as Example A.

  4. In general, if the very limited circumstances criteria is met, examiners should re-characterize the tips as service charges and make the appropriate examination adjustments per above.

  5. In general, if the very limited circumstances criteria are not met, examiners should not re-characterize the tips as service charges, but still must ensure the service charges were reported to the employer and to the IRS as tips. If the service charges were not reported as tips examiners should consider issuing a Section 3121(q) Notice and Demand. Section 3121(q) Notice and Demand is discussed in IRM 4.23.7.7.4.

  6. In Announcement 2012-50, the IRS extended the prospective treatment, under the same very limited circumstances, to amounts paid on or after January 1, 2014. This gave employers an additional year to ensure their policies and accounting systems were in compliance with the guidance issued in Revenue Ruling 2012-18.

  7. Employers that correctly treated service charges as wages are not entitled to a refund of any taxes they may have paid or will pay due to their proper reporting of service charges as wages.

4.23.7.7  (01-22-2010)
Employment Tax Tip Examination

  1. Employment tax tip examinations are initiated when it is determined that the employer is reporting low or zero tips on its Form 941 and tipping is customary in the employer’s industry. In addition, a tip examination is warranted on tipped entities, other than food or beverage establishments if an analysis of tip reporting by the entity indicates a significant amount of unreported tips. The analysis for a tip examination may include, but is not limited to the type and size of the business, the historical tip reporting by the entity, and the Form 8027 data available. For example, the number of slot machines, types of games offered, and number of restaurants in a casino would be considered along with the tips reported on Form 941 and Form 8027 data, to determine if a tip examination is warranted on the casino.

  2. Forms 8027 are analyzed and compared to Forms 941 filed by employers to determine the potential for under-reported tips in the food and beverage industry. A tip examination is warranted if Form 8027 shows charged tips are greater than or equal to total tips reported, or if the Form 8027 indicates that there is a significant disparity between the charge tip rate and the cash tip rate. A tip examination is also warranted if Form 8027 shows allocated tips at a rate lower than 8% and there is no tip rate reduction determination letter for the taxpayer. See IRM 4.23.7.13, Petition for Lower Rate.

  3. Examiners may be assigned a case where the taxpayer is under a voluntary tip compliance agreement described in IRM 4.23.7.10, Tip Rate Determination and Education Program (TRD/EP). These cases involve employers who may not be complying with the requirements of their agreement or who may not be reporting a reasonable amount of tips as wages. A case selected for a compliance review because the taxpayer is not complying with the terms of the agreement will be clearly noted by the classifier. There will be historical information contained in the case file pertaining to the type of tip agreement and any compliance activity the Service has employed to improve compliance by the taxpayer. Compliance reviews are not tip examinations and are conducted differently than a case selected for a tip examination. If you receive a case for a compliance review, contact the NTRCP Policy Analyst for details on these procedures.

  4. If a taxpayer informs an examiner at the beginning of a tip examination that the establishment is under a tip compliance agreement, the tip examination should be immediately discontinued until this fact is verified. As a general policy, the Service will not examine employers under a tip agreement as long as the employer is complying with the terms of the agreement. If the examiner has not reviewed books and records, the examination should be closed using Disposal Code "32," Survey After Assignment. If books and records were reviewed, the examination should be closed using Disposal Code "02," No-Change. If the examiner’s manager believes a future compliance review is appropriate due to egregious noncompliance or an abusive situation, he or she should contact the SB/SE National Tip Reporting Compliance Program Manager to discuss alternatives and future actions.

  5. During the initial interview, examiners should inform the taxpayer that this is not an income tax examination - it is an employment tax examination. Examiners should explain that they will be gathering information to determine the correct tip income earned by the establishment’s employees. Examiners must follow procedures on required filing checks, and if they determine that there are other employment tax issues such as fringe benefits and/or worker classification, examiners should pursue those issues. If these other issues are beyond the examiner's scope, they should consult their manager.

4.23.7.7.1  (12-18-2012)
Report Writing for Tip Examinations

  1. There are unique report writing procedures for employment tax examinations where underreported tip income earned by employees is an issue. These examinations are often referred to as IRC 3121(q) cases. These procedures ensure that tip examinations meet the quality standards and conform to general employment tax report writing procedures.

  2. Cases classified for a "tip examination" should not be limited in scope to tip related issues only. Examiners should perform the required filing checks to ensure the taxpayer is in compliance with other filing, payment, and reporting obligations. Other common issues such as fringe benefits and unreported or underreported compensation should be considered and added to the examination plan when appropriate.

  3. Examiners should conduct the examination to a point where the reported employment tax liability is determined to be substantially correct. Examiners must determine whether information returns such as wage and tax statements have been correctly filed and whether all applicable Federal return requirements have been met. See IRM 4.23.3.7.4, Scope of Employment Tax Examination, for further details.

4.23.7.7.2  (12-18-2012)
Employer Tip Examinations

  1. On June 17, 2002, the Supreme Court rendered a decision in favor of the Service, in U.S. v. Fior d’Italia, Inc. The Court determined that the Service has the authority to assess the employer’s share of social security and Medicare taxes due on employees’ tip income using an aggregate estimation method. In light of this case, the Service may generally conduct tip examinations and make assessments for social security and Medicare taxes on employers only, without first examining the tip records of the individual employees.

  2. As it is critical that examiners meet with the employer and tipped employees to arrive at the correct tip income and to determine the factors affecting how this income is to be reported on the employer’s and employees’ tax returns, the examiner should contact the employer to schedule an appointment. This is generally done by telephone and followed up with Letter 3253, Taxpayer Appointment Confirmation Letter and Letter 3254, Representative Appointment Confirmation Letter. If the examiner is unable to contact the taxpayer by phone, the examiner should mail Letter 3850, Employment Tax Appointment Letter, or Letter 3851, Employment Tax Call-in Appointment Letter. The examiner must enclose an Information Document Request (IDR) with the examiner's confirmation/appointment letters. The IDR should be tailored for the particular taxpayer.

  3. Examiners should establish on AIMS all periods for which books and records are examined, generally all four quarters in a tax year. To ensure proper tracking of audit results, use Project Code "0673" and Activity Code "465" when establishing the employer’s returns on AIMS. Refer to the most recent Project/Tracking Code list from Employment Tax Policy to confirm that the appropriate tracking code is used to identify the examination.

  4. When tip income is an issue, the examiner should determine whether employees are reporting tips to their employer and if the employer is withholding employment taxes as required. The examiner should determine if the amount of tip income reported is reasonably correct. At a minimum, the examiner should consider the following:

    1. Nature of the establishment. Employees of fine dining restaurants generally receive more tips than those of less expensive restaurants since tips are generally a percentage of the customer's bill. The same would apply to tips paid to employees of expensive hotels, beauty shops, etc.

    2. Method of payment. Does the establishment accept cash, checks, credit cards, debit cards, or charge accounts? Are all types of payment reported as tip income by the employee?

    3. Geographical location of the establishment. Different areas have varying tipping habits.

  5. When the examiner determines it is necessary to pursue the unreported tip income issue, the "McQuatters Formula" provides a method of reconstructing tip income that has been accepted by the courts. It specifically addresses factors to be considered in determining a tip rate and the types of items used for making a reduction, such as tip outs and stiff rates. See McQuatters v. Commissioner, T.C. Memo, 1973–240. In McQuatters, the stiff rate (term used when a customer does not tip the server) was applied to the gross sales. With the increased use of credit cards and debit cards, the volume of charge sales that include a tip have also increased. Therefore, applying a stiff factor to gross sales would not be appropriate. In tip examinations, the examiner should apply the stiff rate only to cash sales and charge sales that did not have a tip added to the bill. The stiff factor should not be applied to charge sales including a tip amount. To obtain an electronic version of the calculation worksheet to use, contact an analyst with the National Tip Reporting Compliance (NTRC) Program. However, where the "McQuatters Formula" cannot be applied, the examiner may use any method deemed reasonable to arrive at the correct income. See IRC 446(b).

    Note:

    Treas. Regs. 31.6053-3(j) provides that gross receipts include the retail value of certain complimentary food or beverages. See Treas. Regs. 31.6053-3(j)(16).

  6. In general, for tip examinations, examiners should consider expanding the examination to include the prior and subsequent tax periods.

  7. If an employer has previously entered into a tip agreement that requires setting tip rates, examiners should review these rates as dictated by the tip agreement to determine whether any revisions to the tip rates are needed. For example, gaming tip rates are generally set for three years. See IRM 4.23.7.10, Tip Rate Determination and Education Program (TRD/EP).

  8. If the employer is participating in a tip agreement described in IRM 4.23.7.10 and is complying with the commitments under this agreement, then any social security and Medicare tax assessments made against the employer must mirror those first made against the audited individual tipped employees. There is a specific record layout spreadsheet for use in collecting the tipped employee information. Contact the Program Manager for NTRC Program to get the latest version. As a general rule, Employment Tax Specialists do not perform the tipped employee Form 1040 examinations. The information gathered from the data sheets of the examined employees is used to determine the employer’s social security and Medicare tax assessment. The assessments against the individually audited tipped employees must be completed prior to issuing the Section 3121(q) Notice and Demand to assess the employer’s share of social security and Medicare. The tipped employees’ returns are referred to the appropriate Campus for processing the Form 1040 audits. The Campus then sends the National Tip Reporting Analyst a report on employee assessments for use in issuing the Section 3121(q) Notice and Demand to the employer. However, if the employer is not in compliance with the commitments under the agreement, then tax assessments may be made against the employer without first examining the tip records of the individual employees, but only if the tip agreement has first been terminated.

    Note:

    Before an examiner can initiate an employer-only examination of an employer who is a party to a tip agreement described in IRM 4.23.7.10, the agreement must be terminated. Documentation and other evidence in the case file must establish that the employer failed to comply with the terms of the agreement before the Service can terminate or revoke the agreement. For SB/SE tip agreements, all revocations must be approved by the SB/SE Director of Specialty Programs. For agreements secured by Indian Tribal Government, revocations must be approved by the appropriate Operating Division's designated official.

  9. If the tip examination case resulted from a classification activity (the product of a centralized or NTRCP analyst classification effort), and is a food or beverage establishment, the case file should contain a simulated Form 8027 for each establishment under the employer’s EIN and an IRC 3121(q) Pre-Audit FICA Tax Calculation Worksheet that will provide the examiner with an estimate of the potential IRC 3121(q) liability. It is the examiner’s responsibility to review this information and validate the amounts shown on the Form 8027 using the employer’s books and records. The examiner will then prepare an Examination IRC 3121(q) FICA Tax Calculation Worksheet that will be included with the Section 3121(q) Pre-Notice and Notice and Demand letters sent to the employer.

  10. NTRCP has developed worksheets to assist the examiner in arriving at the correct unreported tip amount and correct tax liability. This worksheet is attached to Letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips, as well as the Section 3121(q) Notice and Demand, Letter 3263-E, Notice and Demand - Employer Only, or Letter 3263, Section 3121(q) Notice and Demand.

  11. The updated worksheets accommodate tip computations that may not have been based on the McQuatters formula and also allow the examiner to consolidate tip computations from multiple venues or establishments. The worksheet is available in two versions:

    1. Single establishment,

    2. Multiple establishments or venues

    The computations on both worksheets are identical, however the multiple establishments/venue worksheets provide a section for listing the individual amounts of underreported tips by establishment/venue. Instructions for completing the worksheet are built into the electronic file. Contact an NTRCP Analyst for electronic copies of these worksheets.

4.23.7.7.3  (01-13-2014)
Report Writing Procedures for Tip Examinations

  1. See Exhibit 4.23.7-2, Chart of Tip Report Writing Instructions, for a summary of scenarios.

  2. The examination of tip related and other employment tax issues involves inspection of an employer’s book and records. The examiner must issue an examination report or no-change letter at the conclusion of each examination. An employment tax liability resulting from a tip examination is considered a current period liability when the notice and demand is issued to the taxpayer. Taxpayer liabilities generated under the authority of IRC 3121(q) require slight deviations from the common report writing procedures.

  3. At the conclusion of an employment tax examination, the examiner will issue Form 4666, Summary of Employment Tax Examination, to the taxpayer. The Form 4666 should address all examined issues, regardless of determination.

  4. In addition to report Form 4666, the examiner may need to issue Letter 4840, Unreported Tips and No Change for Other Examined Issues. Letter 4840 is used when, in addition to the issue of unreported tips, other employment tax issues were examined, resulting in an adjustment to employment tax due to unreported tips; but no adjustment made to the other examined employment tax issues. In addition, Letter 4840 lets the taxpayer know that while there was no adjustment made to taxes for the year of examination, there is a liability due on the unreported tips to be reported as a current period liability. The letter explains when and how the IRC 3121(q) FICA tax liability must be reported.

  5. If the only issue examined is unreported tips and no adjustment is warranted, the examiner issues Form 4666 and Letter 3401-A, Employment Tax No Change Transmittal Letter. Under these circumstances, no specialized report writing procedures are required. The examiner would follow normal employment tax writing procedures as discussed under IRM 4.23.10.6, Notification Letters in No-Change or No-Liability Cases. The examiner will prepare the final no-change letter, Letter 3381, No Change Letter for Employment Taxes, in duplicate, and include in the case file for manager approval and issuance by Centralized Case Processing (CCP).

  6. If the only issue examined is unreported tips and an adjustment to unreported tips is warranted, the examiner will prepare Form 4666 and Letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips, to be included with the examination report package issued to the taxpayer. The examiner will not enter any dollar amount on Form 4666 under column c. This is because the IRC 3121(q) FICA tax liability owed by the taxpayer is reported on the current Form 941 for the quarter corresponding to the date of the Section 3121(q) Notice and Demand. Letter 3264 gives the taxpayer a brief overview of the process for reporting the IRC 3121(q) FICA tax liability and will include a detailed calculation of the additional taxes that will be shown on the Section 3121(q) Notice and Demand. Form 4666 should include the following when the only issue examined was unreported tips and the taxpayer owes additional tax on these unreported tips:

    IRC 3121(q):"The inspection of your books and records resulted in the determination that your employees did not report all of the tips they earned to you, their employer. You owe additional tax on these unreported tips. Once the IRS issues you a Section 3121(q) Notice and Demand for the social security and Medicare tax due on the unreported tips, you will become liable for the employer’s share of the tax under Internal Revenue Code section 3121(q) (IRC 3121(q)).

    The Section 3121(q) Notice and Demand for this tax will be sent to you no sooner than 30 days from the date of this letter, showing tax due of $________ on unreported tips of $________ for the tax year(s) shown above. This letter will provide detailed instructions on how to report and pay this tax. Enclosed with this report you will find Letter 3264, a pre-notice to the Section 3121(q) Notice and Demand. This pre-notice is to give you time to gather the necessary funds and deposit the tax timely, to avoid any possible interest or deposit penalties.

    Future correspondence will provide you guidance on how to properly report and pay the tax to avoid any interest or penalties."


    Note:

    The IRC 3121(q) FICA tax liability is treated as a current tax liability and will be assessed when reported on a current period Form 941 through the Section 3121(q) Notice and Demand process The examiner should not place these adjustments on Form 4668, Employment Tax Examination Changes Report. There is no Form 4668 report prepared for examinations limited in scope to unreported tips since the change in tax is a current period liability.

  7. If there is a determination that all tips were correctly reported but adjustments are warranted to other employment tax issues identified during the course of the examination, the examiner will issue Form 4666 and follow the employment tax report writing and closing procedures in IRM 4.23.10, Employment Tax - Report Writing Guide for Employment Tax Examinations. Under these circumstances, no specialized tip report writing procedures are required.

  8. If other employment tax issues in addition to tips were examined but adjustments are warranted only to unreported tips, the examiner should issue Form 4666 and Letter 4840, Unreported Tips and No Change for Other Examined Issues. When listing the examined issues on Form 4666, the examiner will not enter any dollar amount for the IRC 3121(q) tips issue. Form 4666 should include the language provided below. Letter 4840 informs the taxpayer that the only examined issue that warranted an adjustment was on the unreported tips. Letter 4840 also informs the taxpayer that Letter 3264 Pre-Notice is enclosed with the examination report package. Letter 3264 gives the taxpayer a brief overview of the process for reporting the additional tax and should include a detailed calculation of the additional taxes to be included in the Section 3121(q) Notice and Demand. Add the following language to Form 4666 when, in addition to unreported tips, other employment tax issues were examined but the only issue adjusted is unreported tips:

    IRC 3121(q):"The inspection of your books and records resulted in the determination that your employees did not report all of the tips they earned to you, their employer. You owe additional tax on these unreported tips. Once the IRS issues you a Section 3121(q) Notice and Demand for the social security and Medicare tax due on the unreported tips, you will become liable for the employer’s share of the tax under Internal Revenue Code section 3121(q) (IRC 3121(q)).

    The Section 3121(q) Notice and Demand for this tax will be sent to you no sooner than 30 days from the date of this letter, showing tax due of $________ on unreported tips of $________ for the tax year(s) shown above. This letter will provide detailed instructions on how to report and pay this tax. Enclosed with this report, you will find letter 3264, a pre-notice to the Section 3121(q) Notice and Demand. This pre-notice is to give you time to gather the necessary funds and deposit the tax timely, to avoid any possible interest or deposit penalties.

    Future correspondence will provide you guidance on how to properly report and pay the tax to avoid any interest or penalties."

  9. If the examination results in adjustments to other employment tax issues and adjustments to unreported tips, the examiner must prepare Form 4666 and Form 4668. When listing the examined issues on Form 4666, you will not enter any dollar amount for the IRC 3121(q) tips issue. Form 4666 should include the language provided below in the "Other Information" section. The examiner should also include Letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips. Letter 3264 gives the taxpayer a brief overview of the process for reporting the additional tax and should include a detailed calculation of the additional taxes to be included in the Section 3121(q) Notice and Demand.

    IRC 3121(q):"In addition to the examination changes shown on Form 4668, we also examined tip income. The inspection of your books and records resulted in the determination that your employees did not report all of the tips they earned to you, their employer. You owe additional tax on these unreported tips. Once the IRS issues you a Section 3121(q) Notice and Demand for the social security and Medicare tax due on the unreported tips, you will become liable for the employer’s share of the tax under Internal Revenue Code section 3121(q) (IRC 3121(q)).

    The Section 3121(q) Notice and Demand for this tax will be sent to you no sooner than 30 days from the date of this letter, showing tax due of $________ on unreported tips of $________ for the tax year(s) shown above. This letter will provide detailed instructions on how to report and pay this tax. Enclosed with this report, you will find Letter 3264, a pre-notice to the Section 3121(q) Notice and Demand. This pre-notice is to give you time to gather the necessary funds and deposit the tax timely, to avoid any possible interest or deposit penalties. Future correspondence will provide you guidance on how to properly report and pay the tax to avoid any interest or penalties."


  10. If the examination of the taxpayer’s books and records did not include the examination for employment tax purposes of whether any individuals should be treated as employees of the taxpayer for the purposes of Section 530 of the Revenue Act of 1978, as amended, a statement to that effect should be included on any Form 4666 and/or Form 4668 issued to the taxpayer. See IRM 4.23.10.12.4, Employment Tax No-Change Report.

  11. Section 3121(q) Notice and Demand Procedures and Case Closing are discussed below. See IRM 4.23.7.7.4.

4.23.7.7.4  (12-18-2012)
Section 3121(q) Notice and Demand Procedures

  1. When an employee fails to report tips to the employee’s employer, the employer is not liable for its share of the social security and Medicare taxes on the unreported tips until the IRS makes notice and demand to the employer. See IRC 3121(q).

  2. The employer is liable for the employer’s share of social security and Medicare taxes for tips even though the employees failed to provide the employer with written statements. The additional tax liability may be based upon the employer’s records for the tax year and/or on Forms 4137 filed by employees. The additional tax liability is not due until the IRS issues a Section 3121(q) Notice and Demand (even though the tips were paid to employees in prior years).

  3. No specific form is required for a Section 3121(q) Notice and Demand, but the Service has developed correspondence. The first letter to be issued is Letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips, which is sometimes referred to as a "pre-notice letter."

  4. Generally, the Service will send the taxpayer the pre-notice Letter 3264 at least thirty days prior to issuing the Section 3121(q) Notice and Demand to allow the taxpayer sufficient time to gather the necessary funds for making a timely tax deposit. Examiners must use Letter 3264, to notify the taxpayer of the IRC 3121(q) FICA tax liability.

    1. At the time the pre-notice is issued, the examiner should emphasize to the taxpayer that if a payroll service is used, the taxpayer should immediately notify the payroll service of the IRC 3121(q) FICA tax liability. This is to provide the payroll service provider sufficient time to make the necessary payroll deposit and to help reduce or eliminate any interest or deposit penalties.

    2. It is recommended that examiners issue the Section 3121(q) Notice and Demand within the first 60 days of the quarter to give the taxpayer sufficient time to gather the necessary funds to make the tax deposit and to have sufficient time to notify its payroll service, if there is one, to ensure a timely tax deposit. If the employer reports the IRC 3121(q) FICA tax liability on the line titled "Section 3121(q) Notice and Demand -- Tax due on unreported tips" on the Form 941 for the quarter corresponding to the date of the Section 3121(q) Notice and Demand and makes a timely deposit based on the date of the Section 3121(q) Notice and Demand, the tax due on this liability is interest and penalty free.

  5. Generally, at least thirty days after the Pre-Notice letter is sent to the taxpayer, the Service will send the Section 3121(q) Notice and Demand Letter 3263. This letter will explain how the employer should report and pay the IRC 3121(q) FICA tax liability to avoid penalties and interest.

    1. The employer must report the IRC 3121(q) FICA tax liability on the Form 941 for the quarter corresponding to the date of the Section 3121(q) Notice and Demand. This Form 941 is referred to as the "reporting Form 941."

    2. If the employer fails to report the IRC 3121(q) FICA tax liability on the reporting Form 941, the examiner will initiate an examination of the reporting Form 941 in order to assess the IRC 3121(q) FICA tax liability. This, in essence, constitutes an unagreed report and the examiner then adheres to normal unagreed procedures and reports. Rev. Rul. 2012-18, provides guidelines for IRC 3121 Notice and Demand procedures.

  6. The examiner must post-date the Section 3121(q) Notice and Demand to account for mailing delays and to provide sufficient time following receipt to allow employers to adjust their deposit amounts accordingly. A Section 3121(q) Notice and Demand should not be issued or dated on a Saturday, Sunday, or federal holiday. Therefore, the date on the Section 3121(q) Notice and Demand should be post dated with the last business day of the quarter.

    For example: The examiner mails Letter 3263-E, Notice and Demand - Employer Only, to the taxpayer on February 23, 2012. The date of the Section 3121(q) Notice and Demand is March 30, 2012.

  7. There are two Section 3121(q) Notice and Demand letters for use in employer tip examinations:

    1. Letter 3263-E is used for employer-only examinations where the audit results are not dependent on any audits of the employer’s tipped employees.

    2. Letter 3263 is used for employer tip examinations where the employer has signed a tip compliance agreement. Any assessment against the employer must mirror that first made against the individually audited tipped employees.

  8. For assessments based on the results of the employees' examinations, the examiner may disclose certain information on employee returns in the Section 3121(q) Notice and Demand issued to the employer. This information may be disclosed only if it is necessary to substantiate the employer's share of social security and Medicare taxes on the unreported tip income. The information may be disclosed because it "directly affects" or "directly relates to" the resolution of an issue and there is a transactional relationship between the employer and the employee. See IRC 6103(h)(4)(B) and IRC 6103(h)(4)(C).

  9. When the employer's liability is dependent on the outcome of the tipped employees' audits, then the examiner should attach a spreadsheet to the Section 3121(q) Notice and Demand explaining the tax liability. The examiner may also attach this spreadsheet to the Pre-Notice and Demand. The spreadsheet should include information such as the following:

    1. Employee name, social security number, job position, dollar amount of sales or the number of hours worked

    2. Tip rate used in the calculation

    3. Tips reported by the employee

    4. Unreported tips by the employee

  10. For employer-only audits, there is no requirement to provide a breakdown of the audited employees’ assessments. However, the examiner will attach the McQuatters calculations, or other calculation spreadsheet if McQuatters was not used, to the Section 3121(q) Notice and Demand to show how the liability (aggregate assessment) was determined. When examining a casino, the examiner will attach a spreadsheet showing the unreported tip amounts broken down by the tipped occupational categories.

  11. After the examiner issues the Section 3121(q) Notice and Demand, all quarters examined are closed using Disposal Code "01" , No-Change with Adjustment, unless other adjustments were made to the return. This disposal code should be used regardless of the agreement or lack of agreement by the taxpayer to the proposed IRC 3121(q) FICA tax liability.

  12. The examiner can generally close the exam to the group manager 30 days after the Section 3121(q) Notice and Demand (Letter 3263-E or Letter 3263) was issued to the taxpayer. Once the examiner issues the Section 3121(q) Notice and Demand and the case is ready to be closed, the Form 5344 is prepared. See IRM 4.23.7.7.3 for procedures when other employment tax issues warranted adjustments. If other employment tax issues are examined and an adjustment made, use the primary issue disposal code.

  13. For each quarter examined, complete Form 5344,"Item 418 - 3121(q) Amount," to capture the IRC 3121(q) FICA tax liability. Generally, the IRC 3121(q) FICA tax liability should be spread among all the examined periods in a year in a ratable manner - thus, the amount to enter for each quarter is the social security and Medicare tax amount shown in the Section 3121(q) Notice and Demand divided by the number of quarters examined. For example, if the IRC 3121(q) FICA tax liability is $4,000 and only one year was examined, you would enter $1,000 for each of the 4 quarters examined for the tax year.

    • On Form 5344, if case is closed agreed, enter on line 12 Transaction Code "300" with "0" for the dollar amount.

    • "0" is entered because the additional tax is treated as a current period liability.

    • The Form 941 quarter to be established for the Unagreed Report is the quarter corresponding to the date of the Section 3121(q) Notice and Demand.

    Note:

    The amount you enter on Line 418 is the IRC 3121(q) FICA tax liability, NOT the unreported tip amounts.

  14. On the Form 3198 under "Letter Instructions for CCP," notate:
    "Please validate that the amount on Form 5344, Line 418, matches the amount on the enclosed Section 3121(q) Notice and Demand, Letter 3263."

    1. Attach a copy of the Section 3121(q) Notice and Demand (Letter 3263 or Letter 3263-E) to the inside of the folder (left side).

    2. Retain a copy of the Section 3121(q) Notice and Demand and any work papers which support the computation attached to it. The retained copies of these items are needed if the employer fails to report the IRC 3121(q) FICA tax liability on the reporting Form 941 and an examination of the reporting Form 941 is required. The "reporting Form 941" is the Form 941 for the quarter in which the Section 3121(q) Notice and Demand was dated. The examination will be processed as an unagreed report

  15. Each group must monitor the "reporting Form 941" and must maintain a spreadsheet containing details of monitoring activity and time spent monitoring the reporting Form 941. Make the information available to your manager as needed. Time spent monitoring the filing or assisting the taxpayer in the resolution of an incorrect or non-reporting of the IRC 3121(q) FICA tax liability is recorded under activity code 575-5XX, depending on the type of tipped industry being examined. For example, time spent monitoring a restaurant tip case would be recorded as 575-518. (For additional information on applicable time codes see Exhibit 2, Definitions of Miscellaneous Examination Activity Codes (Direct and Non Direct), in IRM 4.9.1, Examination Technical Time Reporting System - Outline of System.)

  16. After the reporting Form 941 has posted, generally within 2 to 6 weeks following the close of the quarter, the examiner must check IDRS/BRTVU to confirm that the employer properly reported the IRC 3121(q) FICA tax liability shown in the Section 3121(q) Notice and Demand.

    1. For tax years after December 31, 2010, the IRC 3121(q) FICA tax liability is reported on the reporting Form 941, on the line titled "Section 3121(q) Notice and Demand—Tax due on unreported tips."

      Note:

      For Section 3121(q) Notice and Demands issued during tax years 2009 and 2010, this amount was reported on line 7c - "Current quarter's adjustments for tips and group-term life insurance." For Section 3121(q) Notice and Demands issued during tax years 2005, 2006, 2007, and 2008, the amount was reported on line 7e -"Prior quarter's social security and Medicare taxes."

    2. If IDRS research shows that the amount was accurately reported, no further action is needed.

    3. If the tax was not reported, the examiner should first contact the taxpayer to determine if the non-reporting was simply an oversight. The examiner should instruct the employer to file a Form 941-X for the quarter of the reporting Form 941 and pay the tax with the form. If the examiner is unable to resolve the reason for the non-reporting then he or she will establish the reporting Form 941 on AIMS. A limited scope exam, using Project Code "1118" , will be conducted to address the non-reporting of the IRC 3121(q) FICA tax liability. Follow normal employment tax unagreed procedures at IRM 4.23.10.17, Unagreed Employment Tax—Examination Reports.

    Note:

    If an adjustment is made to the "reporting Form 941" for the IRC 3121(q) FICA tax liability, DO NOT enter any value on Item 418 of the Form 5344 when that case is closed.

4.23.7.7.5  (01-22-2010)
Employee Tip Examination

  1. If unreported tip income is identified as a result of an employer tip examination, then the employee and employer are liable for FICA tax on the unreported tip income. The employee is also liable for income tax on the unreported tip income.

  2. Generally, examiners will collect employee information in the form of an "employee record layout spreadsheet" which is forwarded to the SB/SE, National Tip Reporting Compliance (NTRC) Analyst. The NTRC analyst will transmit this information to the appropriate campus. The spreadsheet includes pertinent information regarding the employer’s tipped employees in order to identify employees for examination. The spreadsheet shows the total tips per examination and the potential unreported tips for each tipped employee. The spreadsheet is used by the campus to select the most egregious under-reporters for examination. In addition, the examiner must provide a copy of the McQuatters formula or other calculation showing how the tip rate was determined. Check with the designated NTRC analyst to get an electronic copy of the latest version of the employee record layout spreadsheet.

  3. Indian Tribal Government (ITG) examiners are required to prepare an employee calculation spreadsheet for all tipped employees in each occupational category showing unreported tips. A copy of the spreadsheet should be sent to the ITG Tip Coordinator at the time the employer tip audit is closed.

  4. If the examiner initiates the employee examinations, the employee returns will be established on AIMS immediately after the most egregious under-reporters are identified. Use activity codes 530 through 536. To ensure proper tracking of audit results, use the following project codes:

    • 360: Gaming industry employees (all venues, including food and beverage)

    • 364: Food and beverage industry employees

    • 672: Barber and cosmetology industry employees

  5. Generally, Employment Tax Specialists do not perform the tipped employee Form 1040 examinations; these examinations are processed by a specific Campus. The employee's tax adjustments are made on forms prescribed for individual income tax examinations. Procedures for adjustments to an employee’s tax for tips not reported to the employer are discussed in IRM 4.23.10.19, Procedures for Employee Tax Adjustment on Tip Income Not Reported to Employer. Examiners use Form 4549, Income Tax Examination Changes, to calculate the income tax deficiency on the employee’s unreported tips. The agreement form for additional social security and Medicare taxes due on the unreported tip income is Form 2504-S, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment (including section 530 statement).Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, may be used to secure agreement to the additional income taxes due on the unreported tip income.

  6. Advance payments received for employment tax cases should be reported in accordance with the taxpayer's instructions. Absent instructions, the payments will be reported first as if they were for income tax and the balance will be reported as social security and Medicare taxes.

  7. If the case is unagreed, Letter 525, General 30 Day Letter, is issued for both the social security and Medicare taxes and income tax. Form 2504-S, Agreement to Assessment and Collection of Additional Tax and Acceptance of Overassessment (including section 530 statement), is generated along with the 30-day letter showing the separate computation for the social security and Medicare taxes due. The taxpayer is notified in the report that the social security and Medicare taxes are not included in the deficiency notice and are stated separately on Form 2504-S. If the employee requests an Appeals conference, the employee’s case should be forwarded to Appeals using normal procedures.

  8. If the employee fails to respond to the 30-Day letter, the case should be closed for the issuance of a Statutory Notice of Deficiency on the income tax deficiency and related penalty only. Social security and Medicare taxes, unlike income tax, may be assessed without issuing a Statutory Notice of Deficiency. If a Statutory Notice of Deficiency is to be issued for income tax, the social security and Medicare taxes on the unreported tip income and the related penalty will not be included in the audit report. However, the notice to the taxpayer will include a statement concerning the related social security and Medicare taxes and penalty liability.

  9. Examiners must remember to properly code the tip audit adjustments on the Form 5344, Examination Closing Record, or Form 5599, TE/GE Examined Closing Record. The Service submits this information electronically to the Social Security Administration. The codes can be found in the AIMS Processing Handbook, IRM 21.6.4.4.14.6, Form 4137, Social Security and Medicare Tax on Unreported Tip Income, Adjustments. If these codes are not entered properly, the tipped employee's social security and Medicare wages will not show increase in wages due to the adjusted tip income and the employee will not receive social security credit.

4.23.7.8  (12-18-2012)
Statute of Limitations for Tip Examinations

  1. For employment tax audits where unreported tip income is the sole issue, it is not necessary to extend the statute date on the employer’s Form 941 for the tax year under examination. The statute of limitations for the Service to assess the employer's share of the social security and Medicare taxes on unreported tips is determined by the reporting Form 941 (i.e., the quarter corresponding to the date of the Section 3121(q) Notice and Demand). Accordingly, the examiner is permitted to conduct a tip examination for the employer’s share of the FICA taxes on unreported tips even though the regular statute date could under normal procedures bar the examiner from working that tax period. If a case is assigned to an examiner where the statute date for the tax year under audit causes the system to generate Form 895, Notice of Statute Expiration, follow the following procedures:

    1. Form 895 will be generated based on the month and year of the return’s statute just as they do for all returns where the statute is irregular. This feature is an integral part of the statute control process.

    2. The examiner will complete the Form 895 when the system generates it due to the irregular statute.

    3. Examiners should follow the procedures in IRM 25.6.1, Statute of Limitations - Statue of Limitations Processes and Procedures. Although for an employment tax audit where unreported tip income is the only issue, the statute is governed by the date of the Section 3121(q) Notice and Demand, examiners still need to prepare the Form 895, Notice of Statute Expiration, within the specified time frame of 180 days.

    4. Enter "MM/AD/YYYY" in Section 5.

    5. In Section 6, place a check-mark on the line "Employment Tax Return Examination Limited to IRC 3121(q) (AD)."

    6. In Section 7, enter as remarks "Statute for 3121(q) examination year is determined by the date of Section 3121(q) Notice and Demand."

  2. Once the Section 3121(q) Notice and Demand is issued, the applicable period of limitations is the period of limitations for the employer's Form 941, Employer's QUARTERLY Federal Tax Return, for the calendar quarter in which notice and demand is made and NOT the period(s) of limitations for the returns for the quarters in which the tips were received. As a general rule, the Service generally must assess the employer FICA taxes on the unreported tips within 3 years after April 15th of the calendar year following the year in which the notice and demand is made.

    For example, if the Section 3121(q) Notice and Demand is dated December 31, 2012, the liability is required to be reported on Form 941 for the fourth quarter of 2012, due on January 31, 2013. If the employer timely files the Form 941, the period of limitations for assessment ends on April 15, 2016.

  3. However, if the employer did not file its Form 941 for the fourth quarter of 2012 before April 15 of the succeeding calendar year (April 15, 2013) and instead filed on May 10, 2013, the Service must assess the employer FICA taxes by May 10, 2016, the date three years after the date the return was filed.

    If the employer files a false or fraudulent Form 941 for the quarter in which the adjustment is required to be made or fails to file Form 941 for that quarter, the additional employer FICA taxes on the unreported tips can be assessed at any time.

  4. If it is necessary to extend the statute, use Form SS-10, Consent to Extend the Time to Assess Employment Taxes, to extend the statute of limitations for assessing against the employer additional FICA tax on the unreported tip income. The Service may assess the employer’s share of FICA on the unreported tip income even if it is barred by the statute of limitations from assessing the employee’s share of FICA tax.

4.23.7.8.1  (01-13-2014)
Extending Statute of Limitations for Tip Examinations of Employees (Form 1040)

  1. Form 1040 is a multi-purpose tax return reporting both income and FICA taxes (i.e., social security tax, Medicare tax, and Additional Medicare Tax). If the employee:

    • Did not report any FICA taxes on the return (i.e., the employee did not attach Form 4137 and make an entry on Form 1040 to report FICA tax (Line 57 for 2013 Form 1040)), or

    • Did not attach Form 8919, Uncollected Social Security and Medicare Tax on Wages, and make an entry on Form 1040 to report FICA tax (Line 57 for 2013 Form 1040), or

    • Did not attach Form 8959, Additional Medicare Tax, and make an entry on Form 1040 to report FICA tax (Line 60 for 2013 Form 1040),

    the period of limitations does not begin to run and an assessment of FICA taxes may be made at any time. Therefore, social security tax, Medicare tax, and Additional Medicare Tax on unreported tips can be assessed even if the statute of limitations has expired for the assessment of income taxes. (See Rev. Rul. 79–39, 1979–1 C.B. 435.)

    1. Form 872, Consent to Extend the Time to Assess Tax, or Form 872–A, Special Consent to Extend the Time to Assess Tax, is used to extend the statute for assessing FICA taxes on tips if those forms specify that they relate to those specific taxes. Thus, the kind of tax to specify on the consent is "Social Security and Medicare tax on tips." If Additional Medicare Tax applies, specify "Social Security tax, Medicare tax, and Additional Medicare Tax on tips" on the consent

    2. If income tax and FICA taxes were reported on the same return, the statute for assessment of additional FICA taxes is the same as the statute for the income tax.

    3. If FICA taxes were not reported on the return, there is no statute on the assessment of FICA taxes and an extension is not necessary in order to assess FICA taxes. See Rev. Rul. 79–39, 1979-1 C.B. 435.

  2. Use Form 872 (or Form 872-A) to extend the statute for assessing both income tax and FICA taxes on the employee's unreported tip income if the tipped employee reported any FICA taxes on the employee's Form 1040 and the assessment statute of limitations must be extended. See IRM 25.6.22.6.10.2, FICA Tax on Tips Not Reported to Employer. For additional details on employee tip examinations and statute extensions, see IRM 4.19.15.29,Correspondence Exam Tip Program.

4.23.7.9  (01-13-2014)
IRC Section 45B Credit

  1. The IRC 45B credit applies to employers who operate a food or beverage establishment where tipping is customary and where food or beverages are served for either on- or off-premises consumption. IRC 45B allows an income tax credit to food and beverage businesses for the share of employer's FICA taxes paid with respect to certain employees' tip wages. The employer can claim the income tax credit whether or not the employee reports the tip wages to the employer. Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, is used to compute the credit.

    Note:

    Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. Thus, Additional Medicare Tax has no effect on an employer’s IRC 45B credit.

  2. The taxpayer entitled to the credit is the employee's employer. This is generally the employer under the common law, unless there is another entity that has control of the payment of the wages (e.g., an IRC 3401(d)(1) employer). The application of the common-law rule is a factual determination. Furthermore, the determination of whether an entity is an IRC 3401(d)(1) employer is also a question of fact. See, for example, TAM 201347020, which held that a professional employer organization (PEO), was not eligible to claim the IRC 45B credit on tips received by its clients’ employees because it was not in control of the payment of wages to the employees within the meaning of IRC 3401(d)(1).

  3. PEOs (also commonly known as employee leasing companies) may designate themselves as the employer. A number of court cases have found that a PEO is neither the common law employer nor the IRC 3401(d)(1) employer. Thus, the examiner must first determine, through an examination, who is the employee's common-law employer or the IRC 3401(d)(1) employer before the examiner can determine who is entitled to the credit.

  4. For tips received prior to January 1, 2007: For tips received before January 1, 2007, the IRC 45B credit cannot be offset against the alternative minimum tax (AMT). Pursuant to IRC 38, a taxpayer may claim a general business credit which consists of the aggregate credits identified in IRC 38, including the IRC 45B credit. However, the general business credit is limited by statute. Under IRC 38(c), the credit is computed based on the taxpayer’s "net income tax," which is defined as the taxpayer’s regular tax liability and AMT liability reduced by allowable credits, and the taxpayer’s "net regular tax liability" which is defined as the taxpayer’s regular tax liability reduced by the same credits. While the IRC 45B credit may be used to reduce the taxpayer’s regular income tax liability, it may not be used to reduce the taxpayer’s AMT liability.

  5. For tips received after December 31, 2006: A new provision signed into law on May 25, 2007 allows the IRC 45B credit to be used to offset the AMT liability. The amount of the credit is based on the amount of tips in excess of those treated as wages for purposes of the Fair Labor Standards Act as in effect on January 1, 2007. (i.e., the tip credit is determined based on a minimum wage of $5.15 per hour.) Therefore, if the amount of the minimum wage increases, the amount of the tip credit will not be reduced.

    1. The provision applies to tips received for services performed after December 31, 2006.

    2. Only those credits determined in taxable years ending after December 31, 2006, can be applied against alternative minimum tax. Any credits determined prior to January 1, 2007 and being carried forward cannot be used to offset any alternative minimum tax calculated for years after December 31, 2006. Any credits determined after December 31, 2006, can be used to offset employer’s regular tax and alternative minimum tax (AMT) liability by being carried back to prior years or carried forward to subsequent years.

  6. If the employer pays additional tax as a result of an employment tax examination on unreported tips, the employer may be entitled to an additional IRC 45B credit. If so, the section 45B credit is available to the employer in the year the IRC 3121(q) FICA tax liability is paid and not the year in which the unreported tips were received by the employee.

4.23.7.10  (12-18-2012)
Tip Rate Determination and Education Program (TRD/EP)

  1. Improving compliance behavior among tipped employees continues to be a focus of IRS employment tax initiatives. The Service has explored various methods to achieve voluntary compliance and at the same time reduce the tax burden for employees, employers, and the Service. These efforts resulted in the IRS tip compliance initiative, "The Tip Rate Determination and Education Program (TRD/EP)." The TRD/EP is designed to enhance tax compliance among tipped employees through:

    1. Taxpayer education, and

    2. Voluntary Tip Compliance Agreements

  2. The Service initiated the TRD/EP for various reasons, including:

    1. Education: To help tipped employees and their employers improve their understanding of the laws regarding the federal tax treatment of tips and enhance tax compliance through the use of advance voluntary tip compliance agreements,

    2. Simplification: To make it easier for tipped employees to calculate their tips, report their tips, and pay their taxes, and

    3. Burden Reduction: To reduce the likelihood of a tip examination and ease the financial burdens associated with a tip examination.

  3. There are voluntary tip compliance agreements available that will accommodate all employers whose employees receive tip income. Participating employers sign an agreement with the Service and both sides commit to satisfy certain obligations set forth under the particular agreement. As long as the commitments are satisfied, the Service will not initiate any tip examinations on the employer. Current TRD/EP agreements include:

    1. Tip Rate Determination Agreement (TRDA),

    2. Tip Reporting Alternative Commitment (TRAC),

    3. Employer-designed TRAC (EmTRAC), and

    4. Gaming Industry Tip Compliance Agreement (GITCA).

  4. These voluntary tip compliance agreements help reduce taxpayer burden ordinarily associated with the Service assessments of additional FICA taxes on unreported tip income. The Service, through outreach and education, helps business owners and their tipped employees understand the tax laws related to tip income reporting so that they can more accurately meet their reporting and filing obligations.

  5. Participation in the TRD/EP is voluntary. The employer can choose not to enter into the program, but instead, institute its own program or actions to bring itself and its employees into compliance.

  6. Businesses currently participating in the TRD/EP include food and beverage, cosmetology and barber, and gaming (casino) industries.

4.23.7.10.1  (01-22-2010)
Tip Compliance Agreements

  1. There are specific compliance agreements for the food and beverage, cosmetology and barber, and gaming (casino) industries. There are also generic tip agreements that permit all other tipping industries to participate in the program. The TRDA and TRAC agreements are available to employers in all industries, including restaurants and bars, salons and barber shops, taxicab and limousine companies, airport skycap companies, car wash operations, and tour guide companies. The GITCA is available only to employers in the gaming industry. The EmTRAC is available only to food and beverage employers.

  2. Some employers will find one agreement more beneficial, some will prefer another agreement, and some will choose not to participate in the program at all. As this is a voluntary program, employers do not have to participate. Those who choose to participate may participate in only one agreement at a time. The various agreements can be accessed at irs.gov under Market Segment Understandings.

4.23.7.10.2  (12-18-2012)
Solicitation of Tip Compliance Agreements

  1. IRS employees will under no circumstances use or imply the threat of an audit when soliciting participants to sign up for any tip compliance agreement. Section 3414 of the IRS Restructuring and Reform Act of 1998 specifically prohibits the threat of an audit to coerce taxpayers into signing a TRAC agreement.

  2. The mission of the Service is to provide taxpayers with top quality service by helping them understand and meet their tax responsibilities and to apply the tax law with integrity and fairness to all. The purpose of a tip compliance agreement is to help business employers in industries where tipping is customary to understand their tip income reporting responsibilities, and to promote the compliance by their tipped employees in accurately reporting their tip income.

  3. There are pre-qualification procedures to follow before the agreement can be approved:

    1. When assigned a tip agreement request, read the entire agreement and understand the commitments specified for the IRS and for the Employer.

    2. Contact the employer and review the Employer Commitment sections of the agreement. The Employer needs to demonstrate that everything is in place to satisfy these commitments, before the IRS will approve the agreement.

    3. Evaluate the employer’s level of compliance and ensure that all federal reporting, filing, and payment compliance are current.

    4. If the Employer is a food or beverage establishment, request the most currently filed Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.

  4. After the analysis of the information, if the Service representative determines that the request cannot be approved, contact the taxpayer to explain why. Follow up the telephone contact with Letter 4761, Agreement Request Denial. Letter 4761 explains to the taxpayer why the request to participate in a tip compliance agreement is not being approved. The letter will give the reason or reasons and offer assistance to help get the request approved

  5. Certain pre-filing aspects of the Tip Program have transitioned to the Office of Communications, Liaison, and Disclosure, under the responsibility of the Office of Stakeholder Liaison (SL), with the exception of the Gaming Initiative. SL has primary responsibility for education and outreach to the food and beverage and cosmetology and barbering industries. Generally, SL is responsible for securing TRAC and EmTRAC tip agreements ,but only for businesses with gross receipts of less than $1 million. Any TRDA request is handled by SB/SE Employment Tax field offices.

  6. Employment Tax Operations retains responsibility for all activities related to the Gaming Initiative. This includes securing gaming agreements, monitoring the agreements, and reviewing the tip rates.

  7. If a taxpayer expresses an interest to enter into a voluntary tip compliance agreement during the course of an ongoing examination, the examination must first be completed prior to discussing participation in the program. The taxpayer must understand that where the tax has been determined, a tip agreement will not eliminate any balance due. At the conclusion of the examination, examiners can begin the process of implementing the tip agreement. Note that time on the case for securing an agreement is documented separately.

  8. Once the audit has been finalized, the tip agreement request can be processed by the Employment Tax group where the taxpayer is located. The examination has already determined the correct tip rates for the various worker categories. Therefore, the agent is in a good position to show the employer and the employees the correct way to report cash and charged tips and can more effectively implement the agreement.

  9. Activity Codes:

    • Employment tax examiners should use activity code "551" and Project Code "0985" to report time spent soliciting tip agreements with Source Code "99" and MFT "C0" (C zero).

    • The Tracking Code will depend on the market segment. Contact an NTRCP analyst for the list of Tracking Codes.

    • For tip agreement addendums, use Activity Code "551" and Project Code "0986" .

    • For time spent performing compliance reviews on agreement participants, use Activity Code "551" and Project Code "1104" .

    • Compliance reviews are discussed later.

  10. Delegation orders generally authorize Territory Managers to sign all tip agreements. The authority to approve a Tip Reporting Alternative Commitment (TRAC) agreement or a Tip Rate Determination Agreement (TRDA) is found in SB/SE Delegation Order No. 1-23-20. The Authority to approve a Gaming Industry Tip Compliance Agreement (GITCA) is found in Order No. 4-34 (rev. 1).

  11. For tribal agreements, ITG Group Managers are authorized to sign the tip agreements under Delegation Order 4-34 (rev. 1).

4.23.7.10.3  (01-22-2010)
Tip Rate Determination Agreement (TRDA)

  1. A Tip Rate Determination Agreement (TRDA) requires the employer to work with the Service to arrive at a tip rate for the various worker occupations in the establishment.

  2. At least 75 percent of tipped employees must agree to participate by signing a Tipped Employee Participation Agreement (TEPA) with the employer.

  3. Participating employees comply by reporting tips at or above the rate determined in the agreement for their job category. However, if the employee keeps an actual log of tips, the employee is then only required to report the actual tips received.

  4. If employees fail to report tips at or above the determined rate, the Service may audit those employees’ tax returns.

  5. The TRDA does not have any specific education requirement but the Service provides assistance to help employees understand their tax responsibilities and emphasizes benefits for complying.

  6. TRDA is available for all industries where tipping is customary. The TRDA can be accessed from the IRS website by entering the key words "Market Segment Understandings."

4.23.7.10.3.1  (01-22-2010)
Revoking TRDA Agreements

  1. Revoking any tip agreement requires timely historical documentation on the actions the Service took to help the employer and its employees come into compliance once a decline in reported tips was identified. If a tip agreement is to be terminated, a request for approval must be sent to the Headquarters, Director of Specialty Programs, prior to notifying the taxpayer (employer) through the NTRC Program Manager. The NTRC office will review the request to terminate the agreement and forward to the Director of Specialty Programs for written approval.

  2. Request for approval to terminate a tribal agreement should be sent to the ITG Tip Compliance Coordinator. The Director of Indian Tribal Government must approve all terminations on any Indian Tribal Government tip agreement.

  3. After written approval is received from Headquarters, the Territory Manager must sign the letter notifying the taxpayer of the termination and state the reasons for the termination. Field offices should use Letter 3346, Tip Program Participation Termination Letter, for this notification.

  4. An employer may terminate a TRDA at any time. The Territory Manager may prospectively revoke or terminate a TRDA when, at the end of two consecutive calendar quarters, fewer than 75 percent of the employees in the occupational categories are participating under the agreement, or if the employer fails to file the necessary tax returns, pay and deposit taxes, maintain records or fails to make the required records available to the Service. In addition, if the Service is involved in an administrative or judicial examination, investigation, or proceeding involving the employer or a related party, the agreement may be prospectively terminated by the Territory Manager.

  5. If the employer is otherwise complying with the TRDA, the agreement should not be revoked. As a general rule, individual tip examinations will be initiated on the most egregious noncompliant employees.

  6. For tribal agreements, after written approval is received from the designated Indian Tribal Government (ITG) official, the authorized ITG Group Manager must sign the letter notifying the taxpayer of the termination and state the reasons for the termination. For tribal tip agreements, the designated ITG official may prospectively revoke or terminate a TRDA.

4.23.7.10.4  (01-22-2010)
Tip Reporting Alternative Commitment (TRAC)

  1. Under the Tip Reporting Alternative Commitment (TRAC) agreement, the employer agrees to institute and maintain an employee educational training program with respect to their tip reporting obligations. Unlike a TRDA, a TRAC agreement does not require that the employer work with the Service to arrive at a tip rate for any of the worker occupations in the establishment. However, during the meeting with the Employer to discuss the agreement, the IRS representative responsible for executing the agreement, should jointly review the employer’s books and records to identify the average tip rates for cash and charged tips being received by the tipped employees. This includes a discussion with the directly tipped employees to arrive at tip out percentages (tips shared with other workers) and stiffs (term used when a customer does not leave a tip). This will show the employer and the employees if the employees are reporting their tips accurately. Inform the employer and employees that the Service will monitor tip reporting on the Form 941 and on Form 8027 if pertaining to a food or beverage business. A TRAC requires employers to:

    • Establish a reasonable procedure for accurate tip reporting by all tipped employees,

    • Institute a training program to educate employees of their tax reporting obligations as they relate to tips, and

    • Comply with all federal tax requirements regarding the filing of returns, paying and making tax deposits, and maintaining required records.

  2. TRAC's were originally offered to the food and beverage industry, but have now been extended to all industries where tipping is customary. A specific TRAC agreement is available for the cosmetology and barbering industry containing characteristics unique to this industry.

  3. A TRAC affects all employees. As long as both the employer and employees are complying with the requirements under the agreement and all tips are being reported accurately, no tip audits will be initiated on either the employer or the employees. The Service will only terminate a TRAC agreement if the employer fails to meet the terms of its commitment.

  4. To qualify for a TRAC agreement, the business must have charge receipts that show a charged tip. That is, a reasonable amount of the business’s gross receipts must be from charged receipts that included a charged tip. There is no set percentage - as long as the amount of charged receipts with a charged tip is sufficient to determine the average charged tip rate.

  5. If the reporting of tip wages by tipped employees has not improved after six months from securing the TRAC agreement, the employer will be notified. Specific taxpayer correspondence will notify the employer of any shortfalls in satisfying the agreement commitments and remind the employer about tip reporting obligations and the consequences for failing to comply with the law.

  6. If the underreporting occurs because of the employer’s system, the employer will be offered suggestions for improvements or changes needed to be made to the procedures. If, after a reasonable period the employer has not corrected the procedures, the employer may be referred for a tip examination and/or the agreement may be terminated. Implementation of these follow-up procedures allows the establishments to gauge how well their education requirement is being fulfilled and whether the employees are complying with their tip reporting requirements.

  7. The TRAC can be accessed from the IRS website by entering the key words "Market Segment Understandings."

4.23.7.10.4.1  (12-18-2012)
Revoking TRAC Agreements

  1. Revoking any tip agreement requires the case file to have timely historical documentation on the actions the Service took to help the employer and its employees come into compliance once the decline in reported tips was identified. If a tip agreement is to be terminated, a request for approval must be sent to the Headquarters, Director of Specialty Programs, prior to notifying the taxpayer (employer), through the NTRC Program Manager.

  2. An employer may revoke a TRAC agreement at any time. The Territory Manager may prospectively revoke a TRAC agreement if the employer fails to file the necessary returns, pay and deposit taxes, maintain records or fails to make the required records available to the Service. The Territory Manager may also retroactively revoke a TRAC agreement if the employer fails to substantially comply with the educational program or the tip reporting requirements. In addition to the previously stated reasons, the Territory Manager may revoke the agreement when the Service or other federal agency pursues an administrative or judicial action relating to the employer or establishment that is a party or related party to the agreement.

  3. In the case of an employer with establishments in more than one key area and where one or more establishments are not complying with the requirements under an agreement, the Service, through the controlling office, will notify the employer corporate headquarters. The Service will allow the corporate headquarters a reasonable amount of time to get these establishments into compliance (for example, two quarters). If the noncompliant unit or units do not come into compliance, the Territory Manager may request approval to revoke the entire agreement. The TRAC employer needs to understand that internal controls must be consistent for all establishments to ensure the Agreement as a whole complies with accurate tip income reporting.

  4. If the employer is otherwise complying with the TRAC agreement, the agreement should not be revoked. As a general rule, individual tip examinations should be initiated on the most egregious noncompliant employees.

4.23.7.10.5  (01-22-2010)
EmTRAC – (Employer-designed TRAC) Program

  1. The Employer-designed TRAC (EmTRAC) program retains many of the provisions available under the TRAC agreement. The employer must establish an educational program that trains employees that the law requires them to report all their cash and charged tips to their employer. Education must be furnished for newly hired employees and quarterly for existing employees. The EmTRAC program provides an employer with considerable latitude in designing its educational program and tip reporting procedures, which the employer may combine.

  2. The EmTRAC program is available only to employers in the food and beverage industry.

  3. Procedural and other information regarding the EmTRAC program can be found in Notice 2001-1.

  4. Rules for terminating or revoking an EmTRAC are the same as for a TRAC agreement.

4.23.7.10.6  (12-18-2012)
Gaming Industry Tip Compliance Agreement (GITCA)

  1. The Gaming Industry Tip Compliance Agreement Program (GITCA Program) was designed to promote compliance by gaming industry employers and employees with the provisions of the Internal Revenue Code relating to tip income and to reduce disputes under Section 3121(q). The Gaming Industry Tip Compliance Agreement Program was established in May of 2003 by Rev. Proc. 2003-35. The model GITCA used by the Service and gaming industry employers was updated in 2007 and is now administered under Rev. Proc. 2007-32. The new model GITCA agreement (Rev. Proc. 2007-32, Exhibit 1) was revised to enhance administration of the GITCA program by both the employer and the Service and to facilitate and promote the use of current financial information technology in the tip reporting process. The Revenue Procedure 2007-32, including the GITCA and related appendices, can be found at: http://www.irs.gov/irb/2007-22_IRB/ar13.html

  2. The Gaming Industry Tip Compliance Agreement offers the following:

    1. A two-tiered participation requirement,

    2. Safe harbor from tip-related examinations for participating tipped employees and employer,

    3. Electronic filing of Form 8027 or substitute form used to provide the 8027 required data,

    4. No allocated tip requirement for participating employees,

    5. Flexibility due to economic considerations, and

    6. A self-certification option which reduces the burden of reporting individual payroll and tip information.

  3. The gaming industry offers many unique occupations and terminology. For more information on gaming occupations, see the following Bureau of Labor Statistics website: www.bls.gov/

    1. Select "Occupational Outlook Handbook" (under Publications)

    2. Select "A-Z Index"

    3. Select (G) "Gaming Services Occupations"

4.23.7.10.6.1  (12-18-2012)
GITCA Background

  1. The GITCA, like all other tip agreements, is voluntary. However, once an agreement is entered into by the gaming establishment, the tipped employees will have to decide whether to participate in the program or not. Participation in the program means that the employee will report at or above the established tip rate for their particular worker category. If the employee decides to participate in the program, generally, the employer will automatically calculate the tip income reported for the employee and include that amount on the employee’s Form W-2 at the end of the year.

  2. Under the GITCA Program, a gaming industry employer and the Internal Revenue Service work together to reach an agreement that establishes minimum tip rates for tipped employees in specified occupational categories, prescribes a threshold level of participation by the employer’s employees, and reduces compliance burdens for the employer and enforcement burdens for the Service.

  3. With the consent of the Service, all employers operating a gaming establishment may participate in the GITCA Program. Either the Service or an employer may suggest the employer’s potential participation in the program. The Service’s decision to refuse participation by any employer in this program is not subject to review.

  4. An employer who complies with the reporting requirements of Section V of its GITCA, and participating employees of the employer who report in accordance with the agreement, will be deemed to be in compliance with the reporting requirements of IRC 6053 for the taxable periods during which the agreement remains in effect.

  5. Rev. Proc. 2007-32 went into effect on May 2, 2007 and superseded Rev. Proc. 2003-35. All GITCAs executed pursuant to Revenue Procedure 2003-35 will remain in effect until the expiration date set forth in that Agreement, unless superseded by the execution of a Gaming Industry Tip Compliance Agreement under section 4.02 of Rev. Proc. 2007-32.

4.23.7.10.6.2  (12-18-2012)
Gaming Industry Tip Compliance Agreement (GITCA) Benefits and Responsibilities

  1. The GITCA is an enforceable agreement that must be signed by the employer’s designated representative and the IRS designated official. The person designated by the employer to sign the GITCA must have the authority to legally bind the company/casino. Employees who choose to become participants in the program must sign the Appendix C, "Gaming Employee Tip Reporting Agreement," or similar document and also assume certain responsibilities to maintain their status as participating employees. The similar document can be an agreement that contains similar wording outlined by the employer. Section IV, Employee Participation of the GITCA, discusses the employees’ responsibilities as an eligible and participating employee.

  2. Generally, the IRS and the employer work together to establish tip rates for tipped employees in specified occupational categories. These rates are determined using methodologies in accordance with generally accepted accounting principles.

4.23.7.10.6.2.1  (12-18-2012)
Employer’s Benefits and Responsibilities

  1. The employer agrees to encourage eligible employees to become participants in the program and sign the Appendix C, Gaming Employee Tip Reporting Agreement. In addition, the employer agrees to maintain the Gaming Employee Tip Reporting Agreements for the applicable period (statute of limitation on employment tax assessment) and make the agreements available to the Service upon request. See Section V, Paragraph A of the GITCA.

  2. The employer agrees to make tax withholding based upon tips reported and include all reported tips in the employee’s Wage and Tax Statement, Form W-2. See Section V, Paragraphs B and C, of the GITCA.

  3. The employer agrees to maintain the following records for at least 4 years after the April 15 following the calendar year to which the records relate, and to make those records available to the Service upon request:

    1. Employee records. See Section V, Paragraph E(1) of the GITCA for the specific employee information required to be maintained.

    2. Appropriate gaming establishment records. These records are used in the determination of the tip rates for each specific occupational category. See Section V, Paragraph E(2) of the GITCA for additional information.

    3. Food and beverage operations records. For each food and beverage venue, the employer will maintain gross receipts subject to food or beverage tipping and aggregate receipts showing charged tips. See Section V, Paragraph E(3) of the GITCA for additional information.

  4. The employer agrees to furnish the following to the Service:

    1. An annual report showing each non-participant. This report is due on or before March 31 for the preceding calendar year. See Section V, Paragraph F(1) of the GITCA for more information. An additional annual report providing the same information about participants is required if the employer is not self-certified. See Section V, Paragraph F(2) of the GITCA for additional information.

    2. Specific records pertaining to large food or beverage establishments. The report is due on or before the Form 8027 filing date. See Section V, Paragraph F(3) of the GITCA to determine what information is required. If the records show that allocated tips are required to be reported, the employer should report them on Forms W-2 issued to nonparticipating employees tips allocated pursuant to Section 6053 of the Code. The employer is not required to report allocated tips on Forms W-2 issued to participating employees. In addition, the employer is not required to complete the portion of Form 8027 related to tip allocations to participating employees. See Section V, Paragraph F(4) of the GITCA for additional information.

    3. For each calendar year, the employer will provide a report generated from the employer’s time-and-attendance system or payroll processing system that evidences the tip rates utilized by the employer in the preparation of the Forms W-2 and to implement this agreement. This report will contain information showing the tip rates for each occupational category, shift, and outlet. The report will include the total number of the employer’s eligible employees as of December 31. The report is due on or before March 31 of the year after the calendar year, or any portion thereof, during which this agreement was in effect.

  5. The employer receives the following benefits when entering into a GITCA:

    • Implements its own tip income reporting program for employees

    • Improves knowledge of operations and costs of employees and activities

    • Incurs no contingent liability, except for taxes on non-participating employees’ tip income

    • Is relieved of any employer tip examinations

4.23.7.10.6.2.2  (12-18-2012)
Employee’s Benefits and Responsibilities

  1. Participating employees are the intended beneficiaries of the tip compliance agreement. All eligible employees may become participating employees if they agree in writing to adhere to certain requirements outlined in the agreement and in the Appendix C, Gaming Employee Tip Reporting Agreement, of the GITCA. For purposes of the agreement, a "nonparticipating" employee is any eligible employee who does not meet the definition of a participating employee, as defined in part IV. F of the GITCA.

  2. An eligible employee means an individual who performs a job function in an occupational category described in Appendix A, Occupational Categories, Outlets, Shifts, and Tip Rates, of the GITCA and regularly and routinely receives tips, directly or indirectly, of at least $20 per month.

  3. A participating employee is an eligible employee who fulfills specific requirements. See Section IV, Paragraphs B, C, and E of the GITCA for additional information.

  4. A participating employee who revokes the election under the Gaming Employee Tip Reporting Agreement will be treated as a nonparticipating employee for the entire taxable year in which the revocation occurred. The employee may not enter into a new Gaming Employee Tip Reporting Agreement with the employer until January 1 of the following taxable year.

  5. If a participating employee reports tips to his or her employer in an amount below the tip rate set forth in Section VIII of the agreement, the employee will be deemed to have revoked his or her election under the Gaming Employee Tip Reporting Agreement and will be treated as a nonparticipating employee. The employee may not enter into a new Gaming Employee Tip Reporting Agreement with the employer until January 1 of the following taxable year. See Section IV, Paragraph D of the GITCA for additional information.

  6. An employee may report tips on the employee’s federal income tax return below the tip rates if the employee can substantiate, with adequate books and records, that the employee earned less tip income than would be determined by applying the tip rates. As indicated in Section IV, Paragraph D of the GITCA, this employee would be considered a nonparticipating employee.

  7. Employees who pool tips or their group representatives (example: toke committee) must give the employer a listing of the actual share of pooled tips received by or given to each employee. This listing must reconcile to the tips presented to the employer’s cage for cashing. See Section VIII, Paragraph A(1) of the GITCA for additional information.

  8. Employees receive the following benefits when they participate in the GITCA:

    1. Increased unemployment compensation coverage,

    2. Increased retirement – social security or 401K additions by the employee and employer in a matching situation,

    3. Increased ability to secure loans – mortgage, car, etc. (qualifying),

    4. Increased worker compensation coverage, and

    5. Protection from tip income examination and related liabilities and penalties.

4.23.7.10.6.2.3  (12-18-2012)
IRS Benefits and Responsibilities

  1. The IRS will work with the employer throughout the agreement process to establish reasonable tip rates and to educate the employer concerning its rights and responsibilities as provided for in the agreement.

  2. The employer has the primary responsibility for administering the terms and rates of the agreement once it is signed. However, the IRS should always be available to assist the employer with questions regarding the administration of the agreement and the employer’s related reporting requirements.

  3. The Service may not examine a participating employee’s tip income for any taxable year that ends after the effective date of the agreement, as long as the participating employee fulfills his or her responsibilities as provided in the agreement and Gaming Employee Tip Reporting Agreement.

    Exception: If an employee becomes a participating employee more than 60 days after becoming employed as an eligible employee, the Service may examine the employee’s tip income prior to becoming a participant – unless the employee was a participant in a tip program under another employer or worked in a job or for an employer that did not offer a tip agreement.

  4. The Service may not examine the tip income of a participating employee for any taxable year that ends on or before the effective date of the agreement provided that during that prior period the employee was:

    1. A participant under a predecessor agreement (such as a Tip Rate Determination Agreement (TRDA)) and satisfied all the terms and conditions of that agreement,

    2. A participating employee under another employer who had a GITCA or predecessor agreement and satisfied all the terms of that agreement, or

    3. An employee of an employer who did not have a tip agreement, or for an employer where the individual was not an eligible employee.

  5. The Service may continue any ongoing examination of any employees of the employer begun by the Service before the effective date of the agreement.

  6. A nonparticipating employee is subject to the full range of compliance and enforcement procedures of the Service at any time.

  7. During any taxable year that the agreement is in effect, the Service may not assess additional tax against the employer pursuant to IRC 3121(q) with respect to the tip income of participating employees unless the participating employee reports additional tip income on his/her federal income tax return. The Service may assert a liability against the employer pursuant to IRC 3121(q) based on tips received by a nonparticipating employee if the asserted liability is based upon the final results of an audit or agreement of the nonparticipating employee or the reporting of additional tip income by an employee.

  8. If there is a material breach by the employer of its obligation to maintain or provide the information (reports and documents) listed in the agreement, the IRS will send the employer a notice of demand for the information. If the breach continues, then the IRS is no longer bound by the restrictions on additional assessments.

  9. The burden to examine tip income will be less for the Service as a result of executed tip agreements and employee participation.

  10. The Service will receive a more consistent stream of revenue generated from tax filings of employers and employees.

4.23.7.10.6.2.4  (12-18-2012)
Mutual Responsibilities between the Employer and the IRS

  1. The employer and the IRS agree to meet to discuss the cause of a decline in participation if employee participation is below 75% of eligible employees.

  2. The Service and the employer agree to start discussions as to any appropriate revisions needed to the agreement no later than six months prior to the termination date.

  3. The agreement can be terminated upon the joint agreement of the employer and the Service, without the consent of any participating employee.

4.23.7.10.6.3  (12-18-2012)
SB/SE Employment Tax Procedures – Rate Reviews

  1. SB/SE Employment Tax Rate Review cases are controlled by either of the four territories: East, Mid-States, West, or National Tip Reporting Compliance Program (NTRCP), and coordinated by either a Territory Tip Coordinator, Program Analyst, or Group Manager.

  2. A brief summary of the infrastructure for the processing of Rate Review cases for SB/SE Employment tax:

    • SB/SE ET Territory Coordinator – Subject Matter Expert (SME) who oversees the SB/SE ET Rate Review process for that person’s assigned territory. However, this person will work with the SB/SE ET NTRC Program Analyst upon finalization of the process.

    • SB/SE ET NTRC Program Analyst – Subject Matter Expert (SME) who will work with the SB/SE ET Territory Tip Coordinators upon finalization of the agreement. This person will be responsible for the final rate approval in NTRC.

    • SB/SE ET NTRC Group Manager – oversees the operations of field examiners and works with the SB/SE ET NTRC Program Analyst to ensure rate reviews are properly conducted.

    • SB/SE ET Field Groups – Reviews may be assigned to groups by SB/SE ET Territory Tip Coordinators or SB/SE ET NTRC Program Analyst. SB/SE ET NTRC Group Managers are responsible for assigning reviews to their employees.

  3. The SB/SE ET Territory Tip Coordinators, SB/SE ET NTRC Program Analyst, or SB/SE ET NTRC Group Managers will perform the following initial procedures when a review is established:

    1. Identify specific establishments for the SB/SE ET field examiners to work. This is based on regularly scheduled reviews with specifically identified occupations to review and validate, establishment’s request for a rate review due to a newly opened or remodeled venue, establishment’s request for a rate review due to a change in business operations or economic climate that may impact tipping activities, and the execution of a new agreement with initial tip rates for a new establishment.

    2. Establish the case on ERCS via Form 5345-NTRC and assign the case to a field group (SB/SE ET Territory Tip Coordinators or SB/SE ET NTRC Program Analyst) or assign the case to a field examiner (SB/SE ET NTRC Group Managers). Cases assigned to the SB/SE ET Territory Tip Coordinator will also be established on ERCS via Form 5345-NTRC. Special coding has been established for these reviews. See Exhibit 4.23.7-3 for a listing of these codes.

  4. Upon assignment of a Rate Review case, the SB/SE ET Field Examiner or SB/SE ET Territory Tip Coordinator will perform the following functions:

    1. Perform preliminary research, e.g., internet research, prior agreement information, IDRS, filing of Forms 8027, etc.

    2. Schedule an appointment with the Controller/CFO to meet at the establishment to gather necessary information. The appointment can be scheduled by phone or correspondence.

  5. During the course of the Rate Review process, the SB/SE ET Field Examiner or SB/SE ET Territory Tip Coordinator will perform the following functions:

    1. Walk-through of property (while a virtual walk-through can be conducted, it is beneficial to conduct a physical walk-through).

    2. Secure the following information: list of tipped venues and positions at the establishment, list of any leased establishments with contact information, point-of-sale software information, payroll software information, and customer demographics.

    3. Submit IDR(s) to establishment to gather objective and subjective data to complete all formulas. Streamline process requests limited information.

    4. Develop a mutual commitment date based on discussions with the establishment and either the SB/SE ET Territory Tip Coordinator or SB/SE ET NTRC Group Manager.

    5. Develop rates based on requested information or approve rates submitted by the property.

    6. Discuss errors and questionable factors with the establishment.

    7. Works with establishment to adjust formulas and templates for new occupations, outlets, or changing business practices.

    8. Forward computations, Appendix A or Attachment B, and routing sheet to appropriate SB/SE ET Territory Tip Coordinator or SB/SE ET NTRC Program Analyst for review and approval.

    9. Per Delegation Order DO 4-34 (rev 1), the NTRCP Program Manager signs all GITCA tip agreements.

    10. Issue GITCA or TRDA to establishment.

    11. Assist with employee presentations, if requested.

  6. After the Rate Review process is completed with the establishment, the SB/SE ET Field Examiner or SB/SE ET Territory Tip Coordinator will perform the following functions:

    1. Copy the agreement and prepare the case file for closure.

    2. Forward the original agreement to the establishment.

    3. Submit case file to SB/SE ET Group Manager for closure.

  7. The SB/SE ET Group Manager will forward the closed case file to:

    Internal Revenue Service
    Attn: NTRCP Program Analyst
    110 City Parkway
    Las Vegas, NV 89106

  8. The SB/SE ET Tip Coordinators and SB/SE ET NTRC Program Analyst will assist SB/SE Field Examiners with the following functions:

    1. Provide technical support for agents, conduct field visitations, and provide feedback as necessary.

    2. Provide technical support to agents and to establishments to secure new agreements via traditional rate review, streamline process, or comparables.

    3. Develop a timeline to ensure the timely completion of the rate review engagement.

    4. Assist examiners in employer rate determination discussions and assist the employer conduct presentations.

    5. Communicate challenges and process delays to the SB/SE ET Group Manager, SB/SE ET Territory Manager and/or SB/SE ET NTRCP.

    6. Coordinate the final approval process for the rates computed by examiners.

    7. Obtain feedback on training needs for all types of tip audits and rate reviews.

    8. Make recommendations for changes, additions, or deletions to current formats, procedures, and/or training material relative to the rate review templates, Appendix A and Attachment B.

    9. SB/SE ET Territory Tip Coordinators will provide an electronic Appendix A or Attachment B to SB/SE ET NTRC Program Analyst.

  9. Additional information on the GITCA program can be found in Employment Tax Combined Tip Gaming Training Student Guide, Trng 28136-002 (8-2012), Catalog Number 53650W at: http://publish.no.irs.gov/

4.23.7.10.6.4  (12-18-2012)
Streamline – Introduction

  1. The Service’s goal is to reduce the tip reporting tax gap through employer and employee increased participation in voluntary compliance agreement programs while decreasing taxpayer burden. See IRM 4.23.7.1, Overview. The Internal Revenue Service is always looking for methods to reduce internal administrative burden and external compliance burden. Streamline is a process that:

    1. Modernizes the rate review process,

    2. Engages participants to better understand the voluntary program,

    3. Provides consistency, and

    4. Reduces rate review cycle time through increased engagement.

  2. The Streamline rate review and the traditional rate review process use the same basic factors involving calculation methods, objective factors, and subjective factors. See IRM Section 4.23.7.10.6.3, SB/SE Employment Tax Procedures – Rate Reviews, for information regarding the traditional rate review process. Some of Streamline’s key components are:

    1. An updated methodology to produce tip rates

    2. Usually used after a baseline is established

    3. Consistent information requirements

    4. Employer supplies the majority of the data

    5. Employer populates calculation template(s)

    6. Streamline reduces IRS intrusiveness

    7. Streamline reduces documentation requirements

    8. Streamline increases employer and employee engagement

  3. This method of performing a tip agreement rate review can be used for any business model, not just gaming. It can also be used in the following industries: food and beverage, cosmetology, transportation, etc.

4.23.7.10.6.4.1  (12-18-2012)
SB/SE Employment Tax Procedures

  1. SB/SE Employment Tax Streamline cases will be controlled by one of the four territories: East, Mid-States, West, or National Tip Reporting Compliance Program (NTRCP), and coordinated by an SB/SE ET Territory Tip Coordinator, SB/SE ET NTRCP Program Analyst, or SB/SE ET Group Manager.

  2. A brief summary of the infrastructure for the processing of Streamline cases for SB/SE Employment tax:

    • SB/SE ET Territory Tip Coordinator – Subject Matter Expert (SME) who oversees the SB/SE ET Streamline process for that person’s assigned territory. However, this person will work with the SB/SE ET NTRC Program Analyst upon finalization of the process.

    • SB/SE ET NTRC Program Analyst – Subject Matter Expert (SME) who will work with the SB/SE ET Territory Tip Coordinators upon finalization of the agreement. This person will be responsible for final rate approval in NTRC.

    • SB/SE ET NTRC Group Manager – oversees the operations of field examiners and works with the SB/SE ET NTRC Program Analyst to ensure rate reviews are properly conducted.

    • SB/SE ET Field Groups – Reviews may be assigned to groups by SB/SE ET Territory Tip Coordinators or SB/SE ET NTRC Program Analyst. SB/SE ET NTRC Group Managers are responsible for assigning rate reviews to their employees.

  3. The SB/SE ET Territory Tip Coordinators, SB/SE ET NTRC Program Analyst, or SB/SE ET NTRC Group Managers will perform the following initial procedures when a rate review is established:

    1. Contact the property to introduce the Streamline method and gain the employer’s commitment to the process.

    2. Develop timelines to bring new properties into the Program and ensure the timely completion of the review process. For sample timelines, contact the SB/SE ET Territory Tip Coordinator or SB/SE ET NTRC Program Analyst.

    3. Establish the case on ERCS via Form 5345-NTRC and assign the case to a field group (SB/SE ET Territory Tip Coordinators or SB/SE ET NTRC Program Analyst) or assign the case to a field examiner (SB/SE ET NTRC Group Managers). Cases assigned to the SB/SE ET Territory Tip Coordinator will also be established on ERCS via Form 5345-NTRC. Special coding has been established for these reviews. See Exhibit 4.23.7-1 for a listing of these codes.

  4. Upon assignment of a Streamline case, the SB/SE ET Field Examiner or SB/SE ET Territory Tip Coordinator will perform the following functions:

    1. Perform preliminary research, i.e., internet research, prior agreement information, IDRS, filing of Forms 8027, etc.

    2. Walk-through of property (while a virtual walk-through can be conducted, it is beneficial to conduct a physical walk-through).

    3. Provide formula templates and instructions on how to complete the templates.

    4. Be available to support the employer’s Streamline effort.

  5. During the course of the Streamline process, the SB/SE ET Field Examiner or SB/SE ET Territory Tip Coordinator will perform the following functions:

    1. Reviews the formulas used in each template for mathematical accuracy and reasonableness.

    2. Discusses errors and questionable factors with the employer.

    3. Submits IDR(s) to employer to gather objective data to test template accuracy via sampling.

    4. Works with employer to adjust formulas and templates for new occupations, outlets, or changing business practices.

    5. Forward computations, Appendix A or Attachment B, and routing sheet to appropriate SB/SE ET Territory Tip Coordinator or SB/SE ET NTRC Program Analyst for review and approval.

    6. Per Delegation Order DO 4-34 (rev 1)-NTRCP Program Manager signs all GITCA tip agreements.

    7. Issue GITCA or TRDA to property.

    8. Assist with employee presentations, if requested.

  6. After the Rate Review process is completed with the establishment, the SB/SE ET Field Examiner or SB/SE ET Tip Coordinator will perform the following functions:

    1. Copy the agreement and prepare the case file for closure.

    2. Forward the original agreement to the establishment.

    3. Submit case file to SB/SE ET Group Manager for closure.

  7. The SB/SE ET Group Manager will forward the closed case to:

    Internal Revenue Service
    Attn: NTRCP Program Analyst
    110 City Parkway
    Las Vegas, NV 89106

  8. The SB/SE ET Tip Coordinators and SB/SE NTRC Program Analyst will assist SB/SE Field Examiners by performing the following functions:

    1. Provide technical support for agents, conduct field visitations, and provide feedback as necessary.

    2. Provide technical support to agents and to establishments to secure new agreements via traditional rate review, streamline process, or comparables.

    3. Develop timelines to assist employers with the Streamline process and ensure the timely completion of the rate review engagement. For a sample timeline contact the SB/SE ET Territory Tip Coordinator or SB/SE ET NTRC Program Analyst.

    4. Assist examiners in employer rate determination discussions and assist the employer conduct presentations.

    5. Communicate challenges and process delays to the SB/SE ET Group Manager, SB/SE ET Territory Manager, and/or SB/SE ET NTRCP.

    6. Coordinate the final approval process for the rates computed by examiners.

    7. Obtain feedback on training needs for all types of tip audits and rate reviews.

    8. Make recommendations for changes, additions, or deletions to current formats, procedures, and/or training material relative to the Streamline templates, Appendix A and Attachment B.

    9. SB/SE ET Territory Tip Coordinators will provide an electronic Appendix A or Attachment B to SB/SE ET NTRC Program Analyst.

4.23.7.10.6.5  (01-13-2014)
Large Business and International (LB&I), Tax-Exempt Government Entities (TE/GE), Indian Tribal Gaming (ITG)

  1. Generally, follow normal Rate Review or Streamline review procedures in these cases.

  2. Rate Review or Streamline case reviews may be received from your Industry Office. If you receive a Rate Review or Streamline case review from any other source, immediately contact your Industry Subject Matter Expert. You should receive instructions from your Subject Matter Expert when you receive a Rate Review or Streamline case review. You may want to consult your own IRM section for more information:

    • Large Business and International can be found at IRM 4.51

    • Indian Tribal Gaming can be found at IRM 4.88.1, Indian Tribal Governments Examination Issues and Procedures - Examination Issues Pertaining to ITG Cases.

  3. Examiners and Managers should contact their Subject Matter Expert prior to any contact with the taxpayer. The Subject Matter Expert may use special procedures that should be followed.

  4. Additional information on the Streamline rate review process can be found in Employment Tax Combined Tip Gaming Training Student Guide, Trng 28136-002 (8-2012), Catalog Number 53650W at: http://publish.no.irs.gov/

4.23.7.11  (01-22-2010)
Coordination Procedures for Chain Restaurants

  1. Responsibility for the Tip Rate Determination and Education program involving chain restaurants rests with the IRS Territory where the chain is headquartered. The Headquarters Territory (HQT) is responsible for monitoring the chain as a whole as well as all individual units throughout the chain. Monitoring will include keeping impacted field offices aware of any actions. The HQT office is responsible for providing timely status reports to all affected field offices to include any actions initiated.

  2. The ITG Tip Compliance Coordinator will be responsible for chain restaurants owned by tribal entities. The ITG Tip Coordinator will perform the same functions as listed for the HQT office.

  3. If a field office detects any unit compliance problems or concerns with a chain establishment located in their area, they should contact the HQT office.

  4. The HQT office will contact the taxpayer to discuss any tip compliance problems or concerns and formulate any action plan based upon discussions with the taxpayer.

  5. The HQT office will respond to the field office regarding compliance concerns as soon as possible, but no later than 30 days after receiving the inquiry. In the event that more than 30 days is needed, the HQT office must contact the impacted field office examiner and advise him/her of the current status of the inquiry. No further action by the field office will be taken without first coordinating with the HQT office.

  6. If the HQT office and field office examiner cannot reach an agreement regarding proposed actions/time frames, etc., all concerns should be addressed upward through the regular chains of command, as appropriate. Once the final decision is made on how to proceed, it must be communicated in writing to all affected field offices.

  7. LB&I Cases: If the chain is part of an LB&I entity, follow the same procedures, except that the Team Manager will be contacted and briefed by the HQT office. If the LB&I case is in process, coordinate any contact with the chain through the Team Manager or Team Coordinator. If the LB&I case is not in process, the HQT office will get the Team Manager's approval to make whatever contacts are necessary.

  8. Examination Procedures: Coordinate the examination process through the HQT office, which will be the contact for communication between the field offices and the chain headquarters. The HQT office will provide a "pro-forma" Information Document Request (IDR) for use in non-LB&I cases. For LB&I cases, issue all IDR's through the Team Manager.

  9. Forms 941 Filed in Headquarters Territory: The HQT office will send the Section 3121(q) Notice and Demand to the chain headquarters. If applicable, the Section 3121(q) Notice and Demand will include the closed employee tip examination results for all restaurants in the chain where employee examinations have taken place. The HQT office will follow-up to ensure that the amount(s) reflected on the Section 3121(q) Notice and Demand is (are) paid with the next filed Form 941.

  10. Forms 941 Filed in Affected Field Offices: Follow regular non-chain examination procedures, unless the HQT office requests otherwise. These procedures include issuing a Section 3121(q) Notice and Demand for the employer's share of social security and Medicare tax on unreported tips.

4.23.7.12  (12-18-2012)
Mandatory Compliance Follow-Up Reviews on Voluntary Tip Agreements

  1. Securing the agreement is only the first step in increasing compliance for employers with employees who receive tip income. To ensure employers and their employees continue to report their tip income accurately, it is imperative that the Service monitor the compliance level of the program participants. A unit consisting of workload identification examiners will monitor the various tip agreements as defined in this section.

  2. Follow-up procedures for establishments participating in a TRAC, TRDA, GITCA, or EmTRAC agreement will include a review of the employer's Forms 941. If the program is working, an increase in the tip wages that are reported on Forms 941 should be evident.

  3. Under TRDA and GITCA, tip rates are established for the various worker categories in the establishment. These programs carry a threshold level of employee participation. Consistent with the terms of TRDA and GITCA agreements, at least seventy-five percent of the employees must sign an agreement and agree to report at or above the established tip rate for their job category. NTRCP has developed lead sheets for performing compliance follow ups on TRDAs and GITCAs.

  4. Generally, when an employer enters into a TRDA or GITCA, the employer agrees to review its tip rates, determine whether a tip rate increase/decrease is appropriate, and may submit proposed revisions to the Service by a date specified in its agreement. The Service Representative should follow up to verify whether any rate increases are required if the employer fails to contact the Service by the specified date.

  5. TRAC and EmTRAC do not require any tip rates to be established. However, employers do agree to educate new employees and re-educate continuing employees on a quarterly basis. TRAC also requires the employer to establish a reporting system and to file and pay taxes properly. There are specific lead sheets for performing compliance follow-up reviews. If you are assigned this work stream, contact an NTRCP analyst for the most updated electronic version of these lead sheets.

  6. Tip compliance agreements should be monitored at least annually. For TRAC, if the reporting of tip wages by tipped employees has not improved six months after securing the agreement, the employer should be notified. The Service should correspond with the employer to remind them of their tip reporting obligations and the consequences for failing to comply with the agreement commitments.

  7. Implementation of these follow-up procedures allows each employer to measure the effectiveness of their education program and determine whether the employees are complying with their tip reporting requirements. If noncompliance is identified, then examination referrals should be considered.

  8. Time spent in performing compliance follow-up on agreement participating employers is applied to Activity Code "551." Use the following codes to document time spent on these compliance reviews:

    • MFT "C" 0 (C zero)

    • Source Code "99"

    • Project Code "1104"

    • Lead sheet will list tracking code for the specific market segment

4.23.7.13  (12-18-2012)
Petition for Lower Rate

  1. IRC 6053(c)(3)(A) requires a large food and beverage employer to allocate tips among its tipped employees if the total tips reported to the employer during any payroll period are less than 8% (or the approved lower rate) of the establishment’s gross receipts for that period. The amount to be allocated is generally the difference between the amount reported and the 8 percent. Certain receipts not ordinarily subject to tipping (known as non-allocable receipts) are not considered for this allocation. IRM 4.23.7.5, Information Return Reporting.

  2. Rev. Proc. 86–21, 1986–1 C.B. 560, provides guidelines for employers and employees who wish to petition the Service to have the percentage of gross receipts required to be allocated as tips reduced from 8 percent to a lower percentage (not below 2 percent). Petitions should be sent to the National Tip Reporting Compliance Program Manager. The address and instructions for requesting a reduction in the tip rate are provided in the Instructions for Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips. The Program Manager's secretary will forward the petition to the office where the taxpayer is located.

  3. The petition must contain sufficient information to allow the IRS to estimate with reasonable accuracy the actual tip rate of the establishment. Burden of proof rests with the petitioner (taxpayer).

  4. The user fee may change from year to year. The fee is posted in the first revenue procedure of each calendar year, e.g. for 2013 that would be Rev. Proc. 2013-1. This revenue procedure is updated annually to reflect the new fee, posted under Appendix A. Since the petitioner is requesting a letter ruling determination, the payment for the user fee must be submitted along with the petition for the rate reduction.

  5. This section provides guidelines to IRS field office personnel in determining whether the information submitted with rate reduction petitions supports the granting of such a reduction. Each Employment Tax Territory or field office will designate one or more employees to review tip rate reduction petitions and recommend determinations to the Territory Manager.

  6. If the field office receives the user fee directly from the petitioner/taxpayer, Form 3244–A, Payment Posting Voucher - Examination, must be completed and forwarded with the user fee to the remittance processing area. The user fee and original Form 3244–A need to be transmitted no later than the next working day after receipt. Payments will be forwarded using Form 3210, Document Transmittal. Keep a copy of all the paperwork as evidence that a user fee was collected.

  7. User fees are credited to the general fund revenue account and not to a taxpayer module. Do not enter a form number, MFT, or a tax period on the Form 3244–A, Payment Posting Voucher - Examination. The following must be included on the form:

    1. SSN/EIN,

    2. Transaction date (date user fee received),

    3. Taxpayer name, address, and zip code,

    4. Total user fees received,

    5. In the "Remarks" section, write "USER FEE- DO NOT POST TO MASTER FILE," and

    6. Prepared by (name and symbols).

4.23.7.13.1  (12-18-2012)
Procedures For Tip Rate Reduction Petitions

  1. It is important to note that the information being reviewed is to be evaluated only in terms of granting a rate reduction below 8% and the burden of demonstrating the need for such a reduction is on the petitioner/taxpayer. This is strictly a discretionary area and mechanical formulas using point systems should not be used as the only criteria in making these determinations. Employment Tax personnel reviewing rate reduction petitions should not hesitate to request further information from the petitioner/taxpayer, if needed. If the reviewer is unfamiliar with the area or wants to observe the petitioner/taxpayer's operation, a visit to the establishment should be considered.

  2. If an examiner determines that a rate less than 8% is applicable, a determination letter must be sent to the taxpayer. Letters to be used for notifying the taxpayer are:

    • Letter 8027-A, Determination Letter for Approved Tip Allocation Rate Reduction - less than 10 Employees

    • Letter 8027-B, Determination Letter Approving Specified Lower Rate

    • Letter 8027-C, Determination Letter when Business Meets Cafeteria Style Establishment

    • Letter 8027-D,Tip Rate Reduction Request Denied

    Generally, the period covered by the determination letter is not to exceed three years. At the end of this period, if the employer believes that the circumstances still warrant the use of an allocation percentage of less than eight percent, the employer will have to submit another petition.

  3. Employers requesting tip rate reductions are required to submit certain information, as described in Rev. Proc. 86–21, if applicable, with their tip rate reduction request to the address given in the Instructions for Form 8027. Studies indicate that a tipping rate of 8% is low for most types of restaurants and bars, and the need for any reduction below 8% allocation rate must be fully supported by the information submitted.

  4. The following are guidelines reviewers may use in evaluating tip rate reduction petitions (the sections refer to Rev. Proc. 86–21 sections).

    1. Sections 3.01(a) through 3.01(c)(5), section 3.01(c)(7), and section 3.01(d) of Rev. Proc. 86-21 request a basic description of the establishment and its operations. This description gives information on items that can affect the tipping rate. In establishments where less than full table service is provided, such as self-service or cafeteria type of establishments, the tipping rate may be very low. Another major consideration is the establishment's location and type of clientele. Establishments near college campuses, for instance, may have mostly student customers who may tip at a lower rate. Other factors that may affect the tipping rate include rural versus urban location, full menu versus specialty (such as pizza parlors), and open for lunch only versus open for all meals.

    2. Section 3.01(c)(6) requests financial information about the establishment that may be useful for determining the actual tip rate. For instance, the total sales subject to tipping can be computed by taking the gross sales and deducting carry-out sales and sales with a service charge. Dividing the total sales subject to tipping into the total tips reported to the employer by the employees will provide the tip rate reported by the employees. The total charge tips divided by the total charge receipts with charge tips may give a more reasonable estimate of the establishment's tip rate.

  5. The Instructions for Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips give specific details on the information the taxpayer must submit with the written petition for the tip rate reduction. If the taxpayer has not submitted this information, contact the taxpayer and reference the Instructions for Form 8027 for the information that must be submitted.

  6. The NTRCP Program Manager will assign the case to an NTRCP field group. The case will include a routing checksheet for processing the request.

  7. Time for processing a tip rate reduction petition is applied to Activity Code "551" and Tracking Code "6451" . The routing checksheet provides additional details.

4.23.7.14  (01-22-2010)
Employment Tax Monitoring Unit

  1. Employment Tax Operations will designate specialized resources to monitor the various employment tax programs. One of their duties will be to monitor the agreement inventory to ensure that employers and their employees continue to report their tip income accurately and that the agreement commitments are being satisfied. Follow-up procedures for establishments participating in a tip agreement include a review of the employer's Forms 941.

  2. In general, monitoring the agreements should be done at least annually. If the employer has entered into a tip agreement that requires tip rates, these rates should be reviewed according to the agreement requirements. For GITCAs, this may be every three years. A determination whether or not the rates should be adjusted will be made at that time.

Exhibit 4.23.7-1 
Codes to Complete Form 5345-NTRC


Project Codes: Required to identify the type of review. This information will be used to compile various data reports.

Project Codes  
0985 Rate Reviews
0986 Addendums
1104 Compliance Reviews



Tracking Codes: Required to identify the type of business. This information will be used to compile various data reports.

Tracking Codes  
6455 Hotels
6456 Valet
6457 Other Transportation Companies
7944 Casino (includes all venues owned by the casino)
7945 Racino
7946 Boats to Nowhere
7947 Restaurant (non-casino owned)
7948 Spa (non-casino owned)
7949 Golf Course
7950 Sky Caps
7951 Taxi
7952 Slot Bar
7953 Night Club
7954 Card Room
7955 Cosmetology
7956 Establishment - Initial Agreement (Comparables)
7957 Agreement Enforcement Compliance Activities
7958 Other Tip Positions

Exhibit 4.23.7-2 
Chart of Tip Report Writing Instructions

If Then Issue Report Issue Letter(s)
Tips is the only issue examined and there is no Section 3121(q) liability Follow normal Employment Tax (ET) procedures.

Prepare Form 4666* and issue Letter 3401-A, Employment Tax No Change Transmittal Letter, to transmit the RAR to the taxpayer
Form 4666*, Summary of Employment Tax Examination

See IRM 4.23.10.6, Notification Letters in No-Change or No-Liability Cases
Letter 3401-A

In addition, undated Letter 3381, No Change Letter for Employment Taxes, is to be prepared in duplicate. Both copies are signed by the manager when closed from the group.
Tips is the only issue examined and a tip adjustment is warranted (there is a Section 3121(q) liability). Prepare Form 4666*

Issue letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips with the report form.
Form 4666*

Special language goes on Form 4666.

See IRM 4.23.7.7.3(6)
Letter 3264, Pre-notice for Employer Share of Tax due on Unreported Tips, sent with the Form 4666.

and

Letter 3263, Section 3121(q) Notice and Demand, will be issued at a later date.
Tips and other ET issues were examined and the tips were reported correctly (no Section 3121(q) liability), but adjustments made to other examined ET issues. Examiner follows normal ET exam report procedures.

IRM 4.23.7.7.3(7)
Normal ET exam report procedures.

IRM 4.23.10, Employment Tax Report Writing Guide
Normal ET exam report procedures.
Other ET issues in addition to tips were examined, but adjustment is only to tips. There is a Section 3121(q) liability. Prepare Form 4666

and

Issue Letter 4840, Unreported Tips and No Change for Other Examined Issues
Prepare Form 4666*

Special language goes on Form 4666.

See IRM 4.23.7.7.3(8)
Letter 4840 notifies the TP that tips was the only issue that warranted adjustments and that no changes were proposed for the other examined issues.

The letter also tells the TP that while there is no tax due for the year of examination, there is a tax liability due on the unreported tips. This tax is to be reported as a current period liability.

See IRM 4.23.7.7.3(8)
Tips and other ET issues were examined and all warranted an adjustment. Prepare applicable employment tax RAR forms. Any tax attributable to the unreported tips will not be shown on the report because the tip adjustment is a current period liability. Applicable Form 2504, Form 4666*, F4667, and Form 4668*.

Special language must be entered on Form 4666*.

See IRM 4.23.7.7.3(9)
L4121-E, Employment Tax Report Transmittal Letter, is used to transmit the RAR.

Letter 3264, gives the taxpayer a brief overview of the process for reporting the additional tax and should include a detailed calculation of the additional taxes to be included in the Section 3121(q) Notice and Demand.

See IRM 4.23.7.7.3(9)

Note:

No dollar amounts pertaining to a Section 3121(q) tax are to be entered on Form 4666, Form 4668, or Form 2504 - represented by an asterisk (*) above. This is because a Section 3121(q) tax is treated as a current period liability and not subject to interest or deposit penalty if tax is paid timely by the taxpayer.


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