IRS overlooks billions in tax noncompliance for tips
The Internal Revenue Service isn’t fully addressing billions of dollars in tip-related tax noncompliance and it’s generally not enforcing the tip agreements it has in place with some businesses, according to a new report.
The report, from the Treasury Inspector General for Tax Administration, found that 1,971 (or 30 percent) of the 6,513 businesses that have tip agreements with the IRS that also filed taxes during tax year 2016 had projected unreported tips of nearly $1.66 billion. Employers with Tip Reporting Alternative Commitment agreements accounted for 815 (or 41 percent) of this noncompliance, involving nearly $1.2 billion (or 72 percent), including 47 full-service restaurants that potentially underreported tip income by over $1 million each. Nevertheless, the IRS provided tip income audit protection to these potentially noncompliant businesses and employees.
The report noted there’s an even higher risk of tax noncompliance for employers in tipping industries that don’t have a tip agreement with the IRS. TIGTA found 15,771 employers with $6.3 billion in projected unreported tip income for tax year 2016, including 676 employers who underreported tip income by more than $1 million. Meanwhile, the IRS’s National Tip Reporting Compliance Program completed only 34 tip examinations of employers in fiscal 2016.
A dozen years ago, the IRS estimated that 10 percent ($23 billion) of the estimated 2006 individual income tax underreporting tax gap of $235 billion was due to unreported tip income by employees. It set up a National Tip Reporting Compliance Program, or NTRCP, to oversee compliance of taxpayers in industries in which tipping is customary. The NTRCP prioritized the renewal of lower-risk Gaming Industry Tip Compliance Agreements (GITCAs) and Tip Rate Determination Agreements (TRDAs) over higher-risk compliance reviews of Tip Reporting Alternative Commitment (TRAC) agreements and tip examinations. Since fiscal year 2013, the compliance program completed 875 GITCA and TRDA renewals, compared with 262 tip examinations and 53 TRAC reviews.
IRS officials argue that by focusing on the renewal of GITCAs, they’re able to reach and maintain compliance for a large number of employers and their employees all at once. However, TIGTA determined that many of the GITCA and TRDA renewals it reviewed resulted in either no change to the tip rates or a reduction by an average of 17 percent. Unlike employers that have TRAC agreements with the IRS, employers with GITCA and TRDA deals need to submit annual reports that the NTRCP can use to assess the risk of noncompliance.
TIGTA reviewed the 10 most recently completed tip agreement compliance reviews and found that the NTRCP examiners had documented at least one reason to revoke the tip agreements in a redacted number of the cases, but the agreements weren’t revoked. The NTRCP has revoked only 13 tip agreements since fiscal year 2013.
The report made nine recommendations to improve the NTRCP’s administration of tip agreements and examinations. In response to the report, IRS management agreed with the recommendations and plans to take corrective actions, including the use of more data analysis to identify taxpayers who need a compliance review.
Mary Beth Murphy, commissioner of the IRS’s Small Business/Self-Employed Division, pointed out that the National Tip Reporting Compliance Program is a voluntary compliance and enforcement program and that the IRS has limited resources available to address tip compliance. In 2014, she noted, the IRS created a Centralized Employment Tax Operations unit to assist with compliance activities that hadn’t been performed previously.
“While we have taken these steps to leverage our limited resources, we recognize that more can be done,” she wrote in response to the report. “We plan to use more risk and data analysis in our approach to case selection as well as modify certain procedures to improve our efficiency. We intend to issue guidance on extending renewal terms for tip agreements. We are also going to clarify compliance review procedures and when revocation of tip agreements is appropriate.”