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Wednesday
May022018

IRS Addresses 'Tip Boxes' 

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In a recently released IRS Chief Counsel Memorandum, the IRS addressed cash amounts distributed from “tip boxes.”

As the IRS described the facts, the taxpayer engaged individuals to perform services on its premises; the taxpayer classified the individuals as volunteers, and it did not pay those people compensation or benefits. However, the individuals received cash payments from amounts that customers placed in “tip boxes” near where the services were performed.

As the IRS explained,

Taxpayer places the ‘tip boxes’ to encourage customers to contribute cash amounts to the individuals. Taxpayer does not require customers to make cash contributions and customers have discretion on how much cash to contribute (including zero contribution).

At the end of each shift, then, the individuals decided how to allocate the tip box.  Here, the there was no evidence that the Taxpayer knew the actual amounts received, nor did it issue Forms W-2 or include those amounts on Forms 941.

During an audit, the IRS determined that the volunteers should be treated as employees for FICA tax purposes; consequently, the IRS issued a Letter 3523 to the taxpayer.

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The two questions posed by the memorandum were as follows: (emphisis added)

1. Whether cash amounts distributed to individuals from “tip boxes” are properly classified as tips under the Internal Revenue Code (Code) and subject to Federal Insurance Contributions Act (FICA) tax.

2. Whether cash amounts distributed to individuals from “tip boxes” are subject to notice and demand procedures under section 3121(q) or whether taxes on cash amounts should be included in Table 3 of Letter 3523, Notice of Employment Tax Determination under IRC § 7436.

(footnotes omitted).

Section 3121(q) provides that “tips received by an employee in the course of his employment shall be considered remuneration for such employment . . . .” And, although employers are generally required to deduct and pay over the employee portion of the FICA tax, section 3102(c)(1) provides a special rule for tips. Under that rule, among other things, the employer’s obligation is applicable only to the amount of tips included in a written statement provided by the employee to the employer under section 6053(a).

The term “tips,” however, is not defined in the Code or the regulations. The employer’s classification of the payment as a “tip” is not determinative. However, the IRS explained in Revenue Ruling 2012-18 that the absence of any of the following factors casts doubt on whether the payment is a tip:

(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.

Here, the IRS found that the four factors were present.

Thus, once the amounts were properly identified as “tips,” the FICA timing rules applied. Because the tips were not reported to the employer (as provided in section 6053(a)), as the memorandum explained, “they are deemed to be paid on the date on which the Service issues a notice and demand under section 3121(q) for the taxes to the taxpayer.” Therefore, “the tips are not subject to the employer share of FICA tax until the Service issues a notice and demand under section 3121(q).”

Procedurally, then, the IRS explained that:

The Service should issue Letter 3523 to Taxpayer based on the worker classification determination, and should identify in Table 1 the individuals the Service determined should be reclassified as employees. However, tax on the cash amounts received by the individuals should not be included in Table 3 of Letter 3523 because the tips are deemed paid only after the Service issues a notice and demand under section 3121(q). Thus, the only issue that would be subject to Tax Court jurisdiction would be the proper worker classification of the individuals listed in Table 1.

However, if the amount reported by an employee to the employer (see § 6053(a)) was properly characterized as a tip, it would be deemed paid at the time of the statement and should be included on the Letter 3523. Moreover, “if an amount characterized by an employer as a tip was determined not to be a tip (for example, it was a service charge) tax on the amount should be included in Table 3 at the time Letter 3523 was issued.”

It is important to note that, Letter 3523, which was formally titled, “Notice of Determination of Worker Classification,” is now entitled “Notice of Employment Tax Determination under IRC § 7436.”

Please note that Chief Counsel Advice memoranda cannot be used or cited as precedent. The CCA Memorandum is Number 201816010 (Dec. 4, 2017; released Apr. 20, 2018); you can find it hereThis is only a summary of the CCA and some portions have been omitted or edited -- if you need advice in this area, please review the CCA in its entirety and consult a tax attorney.

Posts are not legal or tax advice & should not be relied upon. Case results depend on facts unique to each case. If you need legal or tax advice, consult a lawyer.

Link to original Forbes Article.

Link to Office of Cheif Counsel Internal Revenue Service Memorandum