IRS ANSWERS QUESTIONS CONCERNING FICA TAX ON EMPLOYEE TIPS.

Rev. Rul. 95-7

The purpose of this revenue ruling is to provide guidelines, in question and answer form, concerning taxes imposed on tips under the Federal Insurance Contributions Act (FICA).

Sections 3101 and 3111 of the Internal Revenue Code impose social security and medicare taxes under the FICA on employees and employers, respectively, equal to a percentage of the wages received by an individual with respect to employment.

Section 3121(a) of the Code defines "wages," for purposes of the FICA, as all remuneration for services performed by an employee for an employer, with certain exceptions. Section 3121(a)(12)(A) excludes from the FICA tips paid in any medium other than cash; section 3121(a)(12)(B) excludes cash tips received by an employee in any calendar month in the course of the employee's employment by an employer, unless the amount of the cash tips is $20 or more. Under section 3121(q) of the Code, tips received by an employee in the course of the employee's employment are considered remuneration for that employment (and are deemed to have been paid by the employer for purposes of the employer portion of the FICA taxes imposed by section 3111(a) and (b)). 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). However, if the employee either did not furnish the statement or if the statement furnished was inaccurate or incomplete, in determining the employer's liability in connection with the taxes imposed by section 3111 with respect to the tips, the remuneration is deemed, for purposes of subtitle F (Procedure and Administration), to be paid on the date on which notice and demand for the taxes is made to the employer by the Secretary.

Section 6053(a) of the Code requires every employee who, in the course of the employee's employment by an employer, receives in any calendar month tips that are wages (as defined in section 3121(a) or section 3401(a)) to report all those tips in one or more written statements furnished to the employer on or before the 10th day of the following month. The employee is to furnish the statements in the form and manner prescribed by the Secretary.

QUESTIONS AND ANSWERS

In General

Q1. What does section 3121(q) of the Code provide?

A. Section 3121(q) of the Code, which was amended by section 9006 of the Omnibus Budget Reconciliation Act of 1987, requires the employer to pay FICA taxes on the total amount of cash (and charge) tips received by the employee up to and including the contribution and benefit base as determined under section 3121(a)(1).

Q2. Does section 3121(q) of the Code apply in situations in which all tips are required by the employer to be turned over to the employer by the employees, and the employer, in turn, distributes the tips among all the employees?

A. No. The tips distributed in those situations are wages when paid by the employer. Section 3121(q) applies only to tips that are received and retained by the employee.

Q3. When did section 3121(q) of the Code, as amended, become effective?

A. Section 3121(q) of the Code, as amended, applies with respect to tips received (and wages paid) on and after January 1, 1988.

Q4. How are tips reported by the employee to the employer?

A. For each calendar month during which an employee receives $20 or more in tips, the employee must give the employer a written statement (or statements) of cash and charge tips by the 10th day of the month after the month in which the tips are received. Form 4070, Employee's Report of Tips to Employer, is available for this purpose.

Q5. Are any tips not required to be reported to the employer?

A. Yes. Tips totaling less than $20 received by an employee during a single calendar month while working for any one employer are not wages for FICA tax purposes and are, therefore, not required to be reported to the employer. If an employee works for more than one employer during a month and receives less than $20 in tips while working for each employer, no tips are required to be reported to any of the employers. Although these tips are not subject to FICA taxes, they are subject to federal income taxes.

Q6. If an employee fails to report tips to his or her employer, how are the FICA taxes paid on those tips?

A. The employer is liable for only the employer portion of the FICA taxes, and the employee is liable for only the employee portion of the FICA taxes on the tips. Thus, separate rules apply to each.

(1) EMPLOYER. If an employee fails to report tips to his or her employer, the employer is not liable for its portion of the FICA taxes on those tips until notice and demand for the taxes is made to the employer by the Internal Revenue Service. See Q&A8 through Q&A13 below.

(2) EMPLOYEE. The employee pays his or her portion of the FICA taxes by completing Form 4137, Social Security Tax on Unreported Tip Income, and filing it with Form 1040, U.S. Individual Income Tax Return. See Q&A14 and Q&A15 below. For further information regarding income and employment taxes on tips, see Pub. 531, Reporting Income from Tips.

Q7. How are FICA taxes paid on tips reported to the employer?

A. The employer withholds and deposits FICA taxes from the employee's regular wages and pays both employer and employee portions of the tax in the same manner as the tax on the employee's regular wages. See Circular E, Employer's Tax Guide, for additional information, including procedures for situations in which the amount of taxes to be withheld with respect to an employee's tips exceeds the amount of wages received by the employee during the pay period. Employer

Q8. How is notice and demand made for purposes of section 3121(q) of the Code?

A. No specific form or procedure is prescribed. Notice and demand is made by the Service when it advises the employer in writing of the amount of tips received by an employee (or employees) who failed to report or underreported tips to the employer. Although no specific form is prescribed, a document will constitute notice and demand if it (1) includes the words "notice and demand" and "section 3121(q)", (2) states the amount of tips received by the employee (or employees), and (3) states the period to which the tips relate. However, such a document will not constitute notice and demand if it states that it is not a notice and demand.

Q9. How does the employer report liability after notice and demand is made?

A. The employer reports the liability by making an adjustment for FICA taxes on the employer's Form 941, Employer's Quarterly Federal Tax Return, for the calendar quarter in which notice and demand is made, and writing "3121(q)" next to the line for adjustments of social security and medicare taxes (currently line 9 on the Form 941). The employer must also include the amount of the section 3121(q) FTD liability on the appropriate Record of Federal Tax Liability (currently line 17 of Form 941 for monthly employers and Schedule B of Form 941 for other employers).

To explain the adjustment described above, the employer attaches a copy of the notice and demand and a Form 941c, Supporting Statement to Correct Information, which the employer identifies in the top margin with "3121(q)." The employer must file a separate Form 941c for adjustments pertaining to a section 3121(q) notice and demand; any other adjustments for the period must be made on a different Form 941c.

Specific instructions for completing Form 941c: Do not complete Part I or Part II. In Part III, column (a), enter "3121(q)" and the year to which the section 3121(q) notice and demand applies (place different years on separate lines). Do not complete columns (b), (c), or (d). In column (e), enter the total tips for the year as shown on the section 3121(q) notice and demand. In column (f), enter the employer portion of the social security tax on the amount in column (e). In Part IV, column (a), enter "3121(q)" and the year to which the section 3121(q) notice and demand applies (place different years on separate lines). Do not complete column (b). In column (c), enter the total tips for the year as shown on the section 3121(q) notice and demand. In column (d), enter the employer portion of the medicare tax on the amount in column (c).

The instructions in this Q&A9 are based on the current versions of Forms 941 and 941c. If those forms change in future years, appropriate revisions will be made in the instructions for the changed forms.

Q10. Which year's social security and medicare rates and contribution bases are used to compute the employer's liability on unreported tips after notice and demand is made?

A. To compute its liability, the employer must use the rates and contribution bases applicable to the year in which the tips were actually received by the employee.

Q11. If the Service determines that an employer's employees have unreported tips and issues to the employer a notice and demand referring to section 3121(q), and if the employer does not report on the appropriate Form 941 the amount shown on the notice and demand, what is the period of limitation for the Service to assess the employer's share of the FICA taxes?

A. The Service generally must assess the employer FICA taxes on the unreported tips within 3 years after April 15 of the calendar year following the year in which the notice and demand is made. Thus, if notice and demand is made on January 26, 1995, the adjustment is required to be made on Form 941 for the first quarter for 1995, due on April 30, 1995. If the taxpayer includes the adjustment on and timely files Form 941, the period of limitation for assessment ends on April 15, 1999. This assessment period applies whether or not the employer properly makes the adjustment required by Q&A9 above. This assessment period also applies whether or not the employer makes the adjustment on a timely filed return.

However, if the employer files the return late and the filing date is after April 15 of the calendar year following the year the notice and demand is made, the Service must assess the employer FICA taxes within 3 years after the date the return was filed. For example, if the taxpayer above files the return on May 10, 1996, the assessment period ends on May 10, 1999.

If the employer files a false or fraudulent Form 941 for the quarter in which the adjustment is required to be made or fails to file Form 941 for that quarter, the additional employer FICA taxes on the unreported tips can be assessed at any time.

Q12. Is the employer subject to interest on the tax liability?

A. No. The employer is not subject to interest on the liability if the employer pays the tax on or before the due date of the Form 941 for the quarter during which notice and demand is made. If the employer fails to pay the tax by the due date of the return, interest will accrue from the due date of the return.

Q13. Is the employer required to deposit tax due on the unreported tips after receipt of notice and demand referring to section 3121(q)?

A. Yes. The employer must make deposits pursuant to section 6302 of the Code and 31.6302-1 of the Employment Tax Regulations. For purposes of applying the deposit rules, the amount of employer FICA taxes attributable to the amount of tips received by the employee (or employees), as shown on the section 3121(q) notice and demand, is treated as employment taxes accumulated by the employer on the date of the section 3121(q) notice and demand. It is the intention of the Service to notify a taxpayer at least 30 calendar days in advance of the issuance of a section 3121(q) notice and demand.

Employee

Q14. Which year's social security and medicare rates and contribution bases are used to compute the employee's liability on unreported tip income?

A. Because unreported tips received by the employee are deemed to be paid to the employee when actually received by the employee, the employee must use the rates and contribution bases applicable to the year in which the tips were actually received.

Q15. Are employees who fail to report tips to their employers subject to a penalty?

A. Yes. Under section 6652(b) of the Code, 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 portion of the FICA taxes on those tips, unless the employee attaches to the employee's Form 1040 a satisfactory explanation showing that the failure was due to reasonable cause and not due to willful neglect. The explanation must be made in the form of a written statement containing a declaration that it is made under the penalties of perjury and setting forth all the facts alleged as a reasonable cause.

DRAFTING INFORMATION

The principal author of this revenue ruling is Karin Loverud of the Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations). For further information regarding this revenue ruling, contact Ms. Loverud on (202) 622-6060 (not a toll-free number).