Tip Wages Subject to Employment Taxes Receive Clarification by IRS

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The Internal Revenue Service issued Revenue Ruling 2012-18 answering a number of questions regarding tip income and employment taxes.

Employers must pay Federal Insurance Contributions Act (FICA) taxes that includes social security and Medicare for its employees.  The taxes are equal to the wages received by the employee.  Wages means all payment for employment including tips.

The IRS answered 15 questions regarding tip income and the responsibilities of the employer and the employee.  Some of the questions and answers appear below.

Question:

Is the characterization of a payment as a “tip” by the employer determinative for FICA tax purposes under section 3121 of the Code?

Answer:

No.  The employer’s characterization of a payment as a “tip” is not determinative.  For example, an employer may characterize a payment as a tip, when in fact the payment is a service charge.  The criteria of Rev. Rul. 59-252, 1959-2 C.B. 215, should be applied to determine whether a payment made in the course of employment is a tip or non-tip wages under section 3121 of the Code.  The revenue ruling 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.  All of the surrounding facts and circumstances must be considered.  For example, Rev. Rul. 59-252 holds that the payment of a fixed charge imposed by a banquet hall that is distributed to the employees who render services (e.g., waiter, busser, and bartender) is a service charge and not a tip.  Thus, to the extent any portion of a service charge paid by a customer is distributed to an employee it is wages for FICA tax purposes.

Question:

How are tips reported by the employee to the employer?

Answer:

The employee must give the employer a written statement (or statements) of cash tips by the 10th day of the month after the month in which the tips are received.  Form 4070, Employee’s Report of Tips to Employer, is available for this purpose and may be found in Publication 1244, Employee’s Daily Record of Tips and Report to Employer.  The statement may be furnished on paper or transmitted electronically.

Question:

If an employee fails to report tips to his or her employer, is the employer liable for the employee and employer shares of FICA taxes on those unreported tips?

Answer:

If an employee fails to report tips to his or her employer, the employer is not liable for the employer share of FICA taxes on the unreported tips until notice and demand for the taxes is made to the employer by the Service.  The employer is not liable to withhold and pay the employee share of FICA taxes on the unreported tips.

The ruling modifies and supersedes Revenue Ruling 95-7.

Read Revenue Ruling 2012-18

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