The Internal Revenue Service’s Chief Counsel has issued a memorandum providing advice on unreported tip income, with the caveat that the advice cannot be used or cited as precedent.

One of the issues that arose was whether cash amounts distributed to individuals from “tip boxes” are properly classified as tips under the Tax Code and subject to FICA tax.

The IRS Chief Counsel Advice also deals with whether cash amounts distributed from tip boxes are subject to notice and demand procedures under Section 3121(q) of the Tax Code or whether taxes on cash amounts should be included in Table 3 of Letter 3523, "Notice of Employment Tax Determination."

The memorandum points out that the cash amounts distributed to individuals from tip boxes are properly classified as tips under the rules in a 2012 revenue procedure and are therefore wages subject to FICA taxes. The distributed cash is also thus subject to the usual notice and demand procedures.

In the specific case that was being asked about, a taxpayer engaged people to perform services on the taxpayer’s premises. The taxpayer treated them as volunteers and didn’t directly pay them any compensation or benefits for their services. However, the workers received cash from customers in nearby tip boxes. The taxpayer didn’t require customers to make cash contributions and customers have discretion on how much cash to give, or to give no tip at all. The amount of cash in the tip boxes was distributed at the end of each shift. The people who worked during a shift decided how to allocate the tips between all of the individuals who performed services during that shift. The taxpayer didn’t have a system in place for the workers to report the amount of cash they received, and there’s no evidence the taxpayer knew the specific amount of cash received by each individual.

The taxpayer doesn’t issue Forms W-2 to the workers and didn’t include any wages or taxes in connection with their services on Form 941. During the course of an audit, the IRS determined that the taxpayer has the right to direct and control the workers as they perform services and said they should be classified as employees for purposes of FICA taxes. In addition to its worker classification determination, the IRS proposed a FICA tax liability related to the unreported cash amount received by the workers. The IRS sent a letter to the taxpayer at the end of the audit, explaining its worker classification determination.

The IRS Chief Counsel noted that under Section 3121(q) of the Tax Code, tips received by an employee in the course of their employment are considered remuneration for that employment.

“For purposes of determining the timing of the employer’s FICA tax liability, the remuneration is deemed to be paid when a written statement including the tips is furnished to the employer by the employee pursuant to Section 6053(a),” said the memorandum. “However, if the employee did not furnish the statement, or if the statement furnished was inaccurate or incomplete, the remuneration is 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 employer. The characterization of a payment as a ‘tip’ by the employer is not determinative for purposes of determining when the employer portion of FICA arises. Section 31.3121(a) -(1)(c) of the Employment Tax Regulations provides that the name by which the remuneration for services is designated is immaterial. Thus, designating a payment as a tip is irrelevant if the amount is paid as compensation by an employer for services.”

The word "Taxes" on the facade of the IRS headquarters in Washington, D.C.
The word "Taxes" on the facade of the IRS headquarters in Washington, D.C. Andrew Harrer/Bloomberg

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