IRS Releases Guidance on Tax Treatment of Tip Income

The Internal Revenue Service has released new information on the difference between tips and service charges.

Revenue Ruling 2012-18 provides question and answer guidance about FICA taxes imposed on tips. The purpose of the revenue ruling, published June 25, is to clarify and update guidelines concerning the taxes imposed on tips under the Federal Insurance Contributions Act and the notice and demand under Section 3121(q) of the Internal Revenue Code. Sections 3101 and 3111 of the Code impose FICA taxes on employees and employers, respectively, equal to a percentage of the wages received by an individual with respect to employment.

Among the questions covered are what tips must be reported to the employer, how are tips reported by the employee to the employer, and how are FICA taxes paid on tips which are reported to the employer by the employee?

If an employee fails to report tips to his or her employer, is the employee liable for the employee share of FICA taxes on those unreported tips? The IRS says yes, the employee is liable for the employee share of FICA taxes on the unreported tips. “The employee pays his or her share of FICA taxes by completing Form 4137, Social Security and Medicare Tax on Unreported Tip Income, and filing it with Form 1040 (or other applicable return in the Form 1040 series) for the year in which the tips are actually received by the employee,” said the IRS.