By: Betsy Johnson
In light of the IRS’ increased efforts to root out and capture unreported income, one of our hospitality clients recently asked us to provide some clarification regarding: 1) the obligations of employees to report tip income; 2) the obligations of employers to report tip income; and 3) the risks of underreporting of the tip income of its employees.
Employee Obligations: Pursuant to the Internal Revenue Code and regulations, employees are required to report as income all tips they retain. Nevertheless, the actual amount that employees report to the IRS is an individual matter between the employee and the IRS. While the employer may have an policy that mandates that employees report all cash tips and provide employees with reports of tips that distributed through credit cards, the employer should not report tips to the IRS on behalf of employees and should not advise employees regarding how much tip income they should report.
Section 6053(a) of the Code requires employees to furnish written statements to their employers reporting all tips received (credit card and cash) in each calendar month. However, employees should be required to report their tips for every pay period so that the total wages and proper FICA withholding can be taken in each pay period. The employees are responsible for reporting their tips to be reported to the IRS back to the employer on a form created by the employer or on the IRS Form 4070.
The IRS publishes a pamphlet for employees which explains how tips should be recorded and reported. It is called the “Guide to Tip Income Reporting."
Employer Obligations: On an annual basis, employers must report tip income reported by employees on IRS Form 8027. The IRS Form 8027 requires that employers report the gross amount of charge tips (tips paid by credit card) for all employees, tips reported by employees, total credit card receipts, and gross sales. The IRS publishes a pamphlet for employers which explains how tips should be tracked and reported called the “Guide to Tip Income Reporting.”
To promote tip reporting compliance, the IRS has established the Tip Reporting Alternative Commitment (TRAC) program. Employers can voluntarily sign an agreement with the IRS to participate in the TRAC program. The TRAC program is part of the Tip Rate Determination/Education Program that the Internal Revenue Service implemented in 1993 to promote tip reporting compliance.
The TRAC program allows employers to avoid liability for FICA contributions where employees underreport tip income. Pursuant to a TRAC agreement, employers agree to:
- Educate the employees about tip reporting
- Establish tip reporting procedures
- Stay current with all employer tax payments and filing obligations
In return for these commitments, the IRS agrees that it will not access FICA taxes due as a result of tip under reporting unless the IRS first examines all of the employees who have under reported tips. The IRS will not initiate any tip audits of employers while the TRAC agreement is in place, but the IRS may continue to conduct individualized tip income examinations of current or former employees.
To satisfy the educational commitment, it is recommended that employers establish a written policy for tipped employees that explains their tip reporting obligations. In addition, employees should receive information regarding tip reporting during their orientation.
The commitment to establish a procedure to encourage employees to report 100% of their tips can be met by providing employees with the IRS Form 4070 and a written or electronic tip statement on a regular or monthly basis which contains all tips attributable to each employee. The statement must include:
- Employee’s name, address and SS number
- Employer’s Name
- Period Covered and Date Reported
- Total Amount of Tips Received by the Employee
- The Employee’s Signature
The procedure should allow employees to verify or correct the report provided by the employer. However, employers should not provide the IRS with a copy of the statement or report the tips recorded on these statements to the IRS on behalf of the employee.
In order to satisfy the commitment to stay current with tax obligations, employers should implement an internal audit and review process to ensure that employees are complying with the tip reporting policy and procedures. The reality is that employees will not report all of their tips and, as a practical matter, employers cannot force employees to do so. Nevertheless, employers should exercise their best efforts to “encourage” (i.e., nudge, nag and/or discipline) employees to comply with the tip reporting policy and rules.
Conclusion: The inaccurate reporting of tips by employees and employers can result in significant liability for unpaid taxes, interest and penalties for employers. In spite of these potential liabilities, employers should not implement a practice of reporting tips to the IRS on behalf of each employees. To do so, may be detrimental to employee morale and retention. In addition, employers who usurp employee control over how much tip income is reported run the risk of having employees seek advice and/or protection from outside sources, such as a union or an attorney. As such, employers must take care in developing and implementing tip reporting policies and practices.
Our "Wage and Hour Blog" contains more posts about the laws regarding tipped employees.