Our nyc cpa office reports that the IRS has extended the time for businesses to comply with the rules regarding the proper characterization of tips and service charges. This extension is provided in order to allow businesses not currently in compliance with additional time to modify their business practices and make needed system changes.
Previously, the IRS issued guidance that clarifies and updates existing guidelines on the taxation of tips. The guidance covers employer and employee obligations under the Federal Insurance Contributions Act (FICA) with respect to tips received by employees. Included in the guidance is a clarification of the classification of a payment as a tip or a service charge. This guidance was originally to be applied to amounts paid on or after January 1, 2013. However, based on the comments received, the IRS has determined that an extension to January 1, 2014, is appropriate.
In general, the tips your employee receives from customers are subject to withholding. Your employee must report cash tips to you by the 10th of the month after the month the tips are received. The report should include tips you paid over to the employee for charge customers, tips the employee received directly from customers, and tips received from other employees under any tip-sharing arrangement. Both directly and indirectly tipped employees must report tips to you. However, an employee is not required to submit a report for any month in which his or her tips are less than $20.
Your employee may report the tips on Form 4070, Employee’s Report of Tips to Employer, or on a similar statement. The statement must be signed by the employee and must include:
the employee’s name, address, and SSN,
your name and address,
the month or period the report covers, and
the total of tips received during the month or period.
Employer FICA Obligations. Tips received by an employee in the course of your employment are considered remuneration and are considered to have been paid by you for purposes of computing your share of FICA taxes. Therefore, as an employer, you are required to pay social security tax on the amount of tips received by the employee up to and including the contribution and benefit base, and to pay Medicare tax on the total amount of tips received by the employee.
However, if the employee either does not furnish the statement or if the statement furnished is inaccurate or incomplete, then the remuneration is considered to be paid on the date on which notice and demand for the taxes is made to you by the Internal Revenue Service (Service). An employee who fails to report tips required to be reported to an employer is subject to a penalty equal to 50 percent of the employee share of FICA taxes on those tips, unless the employee can provide a satisfactory explanation showing that the failure was due to reasonable cause and not due to willful neglect.
Credit for Employer Share of FICA Taxes Paid. A tax credit is available to businesses that provide, deliver, or serve food or beverages for consumption. Qualified employers may claim a credit for Social Security and Medicare taxes paid or incurred on certain employees’ tips. Generally, the credit equals the amount of employer Social Security and Medicare taxes paid or incurred on tip income in excess of the Federal minimum wage rate that was in effect on January 1, 2007.
For purposes of applying these rules, it is important to distinguish tips from service charges. For example, an employer may characterize a payment as a tip, when in fact the payment is a service charge. Specific criteria should be applied to determine whether a payment made in the course of employment is a tip or non-tip wages.
The absence of any of the following factors creates doubt as to whether a payment is a tip and may indicate that the payment is, in fact, a service charge:
the payment must be made free from compulsion;
the customer must have the unrestricted right to determine the amount;
the payment should not be the subject of negotiation or dictated by employer policy; and
generally, the customer has the right to determine who receives the payment.
For example, 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 and not considered tips for computing the tax credit.
Although the IRS has provided a one year extension for the proper treatment of tips and service charges, all employers with establishments where tipping is customary should review their operations to ensure they understand the difference and are in compliance with IRS guidance as soon as possible. In addition, there may be an opportunity to take advantage of the available tax credit. Please call our nyc cpa New York City tax office for an appointment. We will be happy to assist you with this or other New York City or New York state tax issues.