Tip Reporting (members ed.)
Tip Reporting Option Comparison Chart
Accurate tip reporting is an important human resources management activity for restaurateurs. There are two basic option for reporting tip income to the federal government:
1. Tip Rate Determination Agreement (TRDA)
2. Tip Reporting Alternative Commitment (TRAC)
No subsequent tip examination as long as a TRDA or TRAC arrangement is in effect.
Employers receive a credit allowance for FICA taxes paid on tips reported by employees in excess of the minimum wage.
TRDA TRAC TRDA requires the IRS to work with the establishment to arrive at a tip rate for various occupations in the restaurant. TRAC does not require that a tip rate be established but it does require the employer to: TRDA requires the employee to enter into a Tipped Employee Participation Agreement (TEPA) with the employer. TRAC does not require an agreement between the employee and the employer. TRDA requires the employer to get 75% of the employees to sign TEPAs and report at or above the determined rate. TRAC affects all (100%) employees. TRDA provides that if employees fail to report at or above the determined rate, the employer will provide the names of those employees, their social security numbers, job classification, sales, hours worked and amount of tips reported. TRAC provides that if the tip rate does not improve collectively, the TRAC may be revoked. If revoked, the employer could be subject to a TRDA or tip examination. TRDA has no specific education requirement. TRAC includes a commitment by the employer to educate and reeducate quarterly all directly and indirectly tipped employees and new hires of their statutory requirement to report all tips to their employer. TRDA participation assures the employer that prior periods will not be examined during the period that the TRDA is in effect. TRAC includes the same rules. TRDA results in the mailing of a notice and demand to employer for the employer’s portion of FICA taxes on unreported tips determined for the six-month period used to set the tip rate(s). TRAC has no validation period. Therefore, no notice and demand is appropriate. TRDA prevents employer (only) assessments during the period that the agreement is in effect. TRAC contains a similar provision.
Which Option Is Right for You?
Who Should Apply
How to Apply
When to Apply
For More Information
Who Should Apply
All employers with establishments where tipping is customary should review their operation. Then, if it is determined that there is or has been an underreporting of tips, the employer should apply for one of the two options.
How to Apply
To enter into one of the arrangements, submit an application letter to your area IRS Chief, Examination/Compliance Division, Attn: Tip Coordinator. The Tip Coordinator can provide a letter format as well as more information about each of the arrangements.
When to Apply
An employer may apply for either one of the two arrangements at any time. The effective date of the arrangement is determined by receipt and handling of the employer’s application.
For More Information
The following IRS forms and publications relating to tip income reporting can be downloaded directly from the government website under the heading Forms and Publications by Number :
http://www.irs.gov/forms_pubs/index.html
Pub 505 - Tax Withholding and Estimated Tax
Pub 531 - Reporting Tip Income
Form 941 – Employer’s Quarterly Federal Tax Return
Form 4137 - Social Security and Medicare Tax on Unreported Tip Income
Form 8027 - Employer’s Annual Information of Tip Income and Allocated Tips
Employee Tip Reporting FAQs
As an employee of a food and beverage establishment, the tip income you receive – whether it’s cash or included in a charge – is taxable income. As income, these tips are subject to federal income tax, social security and Medicare taxes, and may be subject to state income tax as well.
Q: What tips do I have to report?
A: If you received $20.00 or more in tips in any one month you should report all your tips to your employer so that federal income tax social security and Medicare taxes, and maybe state income tax can be withheld.
Q: Do I have to report all my tips on my tax return?
A: Yes. All tips are income and should be reported on your tax return.
Q: Is it true that only eight percent (8%) of my total sales must be reported as tips?
A: No. You must report to your employer all (100%) of your tips except for the tips from any month totaling less than $20.00. The 8% rule applies to employers.
Q: Do I need to report tips from other employees?
A: Yes. Employees who are indirectly tipped by another employee are required to report "tip outs."
Q: Do I have to report tip-outs that I pay to indirectly tipped employees?
A: If you are a directly tipped employee, you should report to your employer only the amount of tips you retain. Maintain records of tip-outs with your other tip income (cash tips, charged tips, split tips, tip pool).
Q: What records do I need to keep?
A: You must keep a running daily log of all your tip income.
Q: What can happen if I don not keep a record of my tips?
A: Underreporting could result in your owing substantial taxes, penalties, and interest.
Q: If I report all my tips to my employer, do I still have to keep records?
A: Yes. You should keep a daily log of your tips so that in case of an examination, you can substantiate the actual amount of tips received.
Q: Why should I report my tips to my employer?
A: When you report your tip income to your employer, the employer is required to withhold federal income tax, social security and Medicare taxes, and maybe state income tax. Tip reporting may increase your social security credits resulting in greater social security benefits when you retire. Tip reporting may also increase other benefits to which you may become entitled, such as unemployment benefits or retirement benefits. Additionally, a greater income may improve financing approval for mortgage, car, and other loans.
Q: I forgot to report my tip income to my employer, but I remembered to record it on my federal income tax return. Will that present a problem?
A: If you do not report your tip income to your employer, but you do report the tip income on your federal income tax return, you may owe a 50% social security and Medicare tax penalty and be subject to a negligence penalty and possibly an estimated tax penalty.
Q: If I report all my tips but my taxes on the tips are greater than my pay from my employer, how do I pay the remaining taxes?
A: You can either pay the tax when you file your federal income tax return or you can reach into your tip money and give some to your employer to be applied to those owed taxes.
Q: What can happen if I don’t report my tips to the IRS?
A: If the IRS determines through an examination that you underreported your tips, you could be subject to additional federal income tax, social security and Medicare taxes, and maybe state income tax. Also, a penalty of 50% of the additional social security and Medicare taxes, and a negligence penalty of 20% of the additional income tax, plus interest may apply.
Q: What is my responsibility, as an employee, under the Tip Rate Determination Agreement?
A: You are required to file your federal tax returns. You must sign a Tipped Employee Participation Agreement proclaiming that you are participating in the program. To stay a participating employee, you must report tips at or above the tip rate determined by the agreement.
Q: What is my responsibility, as an employee, under the Tip Reporting Alternative Commitment
A: Directly tipped employee:
Your employer will furnish you a written statement (at least monthly) reflecting your charged tips.
You are to verify or correct this statement.
You are to indicate the amount of cash tips received.
When reporting your cash tips, you should remember that there is a correlation between charged tips and cash tips.
You may be asked to provide the name and amount of any tip-outs to indirectly tipped employees.
Indirectly tipped employee:
You are required to report all your tips to your employer.
Increased proof of income when applying for mortgage, car, and other loans.
Increased unemployment benefits.
Increased retirement plan contributions (if applicable).
Increased workers’ compensation.
No subsequent tip examination is imposed as long as terms of the arrangement have been met and all tips have been reported.
