IRS Releases New Tax Compliance Guidelines Relating to Tips, Service Charges

July 27, 2012
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Restaurant owners may be required to update their tips reporting systems to fall in line with new guidelines released by the Internal Revenue Service. The new rules will affect employers’ and employees’ compliance with federal tax law. For example, the guidelines dictate that all service charges paid to employees under the new rules are deemed as paid by employers for FICA tax purposes. In addition, the federal tax agency released new benchmarks to differentiate between service charges and tips. In order to be deemed a tip, four conditions must be satisfied. First, tips must be made free of compulsion. Second, the customer must have the unrestricted right to determine the amount he or she leaves the employee. Third, the payment should not be the subject of negotiation or dictated by employer policy. Finally, the customer must have the right to determine who receives the payment. If any one of these conditions are not met, the money left may be deemed a service charge. The IRS clarifies with an example. If the employer requires that parties of six or more pay an 18 percent gratuity, this amount is classified as a service charge and must be allocated toward FICA taxes for the employee. However, if there is no policy governing gratuity amounts or requirements, the money is counted as a tip. The new guidelines also require employees who receive tips of more than $20 during the calendar month to report the amount to their employer. These tips are to be considered wages for FICA tax purposes. Tips included under the guidelines include cash tips, debit or credit card tips, and those divided by other employees in a tip-sharing program. The new rules will go into effect on January 1, 2013. The IRS said the timeline should give business owners enough time to update their reporting systems.