On June 20, 2012, the Internal Revenue Service released Revenue Ruling 2012-18, along with a copy of a June 7, 2012 memorandum instructing IRS employment tax examiners how to apply the Revenue Ruling, and Announcement 2012-25 explaining why the memorandum was issued to examiners and requesting public comment on the memorandum.
Executive Summary: On June 20, 2012, the Internal Revenue Service released Revenue Ruling 2012-18, along with a copy of a June 7, 2012 memorandum instructing IRS employment tax examiners how to apply the Revenue Ruling, and Announcement 2012-25 explaining why the memorandum was issued to examiners and requesting public comment on the memorandum.
The Revenue Ruling discusses the assessment of employer FICA taxes on tips, including the application of section 3121(q) of the Internal Revenue Code (the "Code") and the application of the credit allowed under section 45B of the Code, but warns that it is first necessary to determine whether a payment is actually a "tip" for these purposes, noting that it makes no difference what the payment might be called. Even though described as a "tip," a payment that constitutes a "service charge" is wages, and is subject to withholding and reporting as such.
The Revenue Ruling states that the Service will continue to apply existing authority (i.e., Rev. Rul. 59-252) in order to determine whether the payment is a tip or a service charge. Under the principles of Rev. Rul. 59-252, the determination is based on the facts and circumstances. However, four conditions must exist for a payment to be classified as a "tip"; the absence of any of the factors indicates that the payment may be a service charge. Those four requirements are:
- the payment must be made voluntarily, without any compulsion;
- the customer must be free to determine the amount of the payment;
- the payment cannot be dictated by employer policy or be subject to negotiation; and
- the customer must generally have the right to determine who is entitled to receive the payment.
The Revenue Ruling states (in an example) that where, e.g., an 18% charge is automatically added to a restaurant bill for parties of 6 or more, the added charge is a service charge, not a tip. On the other hand, neither "pooling" of tips nor "tipping out" will affect the characterization of amounts that otherwise qualify as "tips." This example is consistent with a similar example from Revenue Ruling 59-252, stating that a fixed fee added to a banquet bill by a hotel, and distributed among the servers, bussers and bartenders who worked the banquet, was a "service charge" and therefore "wages."
The accompanying Announcement 2012-25 contains administrative guidelines that have been provided by the IRS to employment tax examiners. Although Revenue ruling 2012-18 is retroactive, and in large part merely updates existing authority, the Announcement and the guidance memorandum state that, in limited circumstances, examiners should apply the Revenue Ruling prospectively only, to amounts paid beginning January 1, 2013, when determining whether an amount is a "tip" or a "service charge." Those "limited circumstances" are where the particular situation has not been addressed by prior guidance and where the employer involved needs additional time to "amend its business practices and make systems changes" in order to comply. (In this regard, the memorandum lists several revenue rulings that have addressed various factual situations in this context.) The Announcement also requests public comments on the interim guidance memorandum, and whether additional compliance time is needed.
Finally, the Service indicated that a future Announcement will also solicit public comments on proposed changes to the existing voluntary tip compliance agreements. Specifically, significant changes are being proposed to the Tip Reporting Alternative Commitment (TRAC) program and other variations of TRAC agreements, available at http://www.irs.gov/businesses/small/article/0,,id=98944,00.html. The Service intends to update its forms of voluntary tip compliance agreements to better reflect computations derived using Point of Sale systems and the use of electronic payment methods.
If you have any questions regarding this Alert, please contact the author, Jeffrey Ashendorf, jashendorf@fordharrison.com, who is a partner in our New York City office and a member of FordHarrison's Employee Benefits practice group, or the FordHarrison attorney with whom you usually work.