IRS Establishes New Voluntary Tip Reporting Program

Service Industry Tip Compliance Agreement Program

PURPOSE

This notice sets forth a proposed revenue procedure that establishes the Service Industry Tip Compliance Agreement (SITCA) program, a voluntary tip reporting program offered by the Internal Revenue Service (IRS) to employers in the service industry (excluding gaming industry employers)¹. The SITCA program is intended to replace the Tip Reporting Alternative Commitment (TRAC) program and the Tip Rate Determination Agreement (TRDA) program, as set forth in Announcement 2001-1, 2001-2 I.R.B. 277, as well as the Employer-Designed Tip Reporting Program (EmTRAC), as set forth in Notice 2001-1, 2001-2 I.R.B. 261. The proposed revenue procedure provides that upon termination of the TRAC, TRDA, and EmTRAC programs, employers with existing tip reporting agreements in those programs will have a transition period during which their existing agreements will remain effective. The transition period will end upon the earliest of (1) the employer's acceptance into the SITCA program, (2) an IRS determination that the employer is noncompliant with the terms of the TRAC, TRDA, or EmTRAC agreement, or (3) the end of the first calendar year beginning after the date on which the final revenue procedure is published in the Internal Revenue Bulletin. The IRS is issuing this guidance in proposed form to provide an opportunity for public feedback.

BACKGROUND

The Tip Reporting Determination/Education Program (TRD/EP) was designed by the IRS to enhance tax compliance through educational programs and the use of voluntary tip reporting agreements instead of traditional audit techniques. Since 1995, TRD/EP has offered employers in the food and beverage industry the opportunity to enter into TRAC agreements. In general, TRAC agreements require employers to establish an educational program for tipped employees and tip reporting procedures for cash and charged tips. In 1996, TRD/EP began offering employers in certain other industries the opportunity to enter into TRAC agreements and introduced the TRDA program, which is available to employers in a variety of tipping industries and requires the determination of minimum tip rates based on occupational categories that employees must use to report tips to the employer. The decision to enter into a TRAC or TRDA agreement has always been voluntary.

In 2000, the IRS simultaneously published a series of announcements requesting comments on proposed new and revised TRAC agreements and TRDAs for various industries.² Under the TRDA program, the IRS and the employer work together to arrive at a tip rate for the employer's various occupational categories, and employees enter into Tipped Employee. Participation Agreements (TEPAs) with their employers to report tips at the agreed upon tip rates. The TRAC agreements do not require employers or employees to report at agreed upon tip rates but do require employers to (1) implement educational programs for their employees for reporting tips and (2) establish a procedure under which a written or electronic statement is prepared and processed on a regular basis (no less frequently than monthly), reflecting all tips for services attributable to each employee. At the same time, the IRS also published Notice 2000-21, 2000-1 C.B. 967, which set forth the requirements employers in the food and beverage industry must meet to participate in the new EmTRAC program. The EmTRAC program is similar to the TRAC program but was created for employers that wish to submit their own educational programs and tip reporting procedures for approval by the IRS. Notice 2000-21 requested comments on all aspects of the EmTRAC program, and specifically on what types of electronic tip reporting systems would meet the educational requirement.

Those proposed TRAC, TRDA, and EmTRAC programs all provided a commitment that the IRS would provide protection to the employer from section 3121(q) liability³ by not initiating any tip examinations of the employer for periods in which the agreements were in effect. The proposed TRDAs included a similar commitment for employers with respect to their employees who reported tips at or above the tip rate established for the employee. TRAC agreements did not specifically provide tip examination protection for employees, but the IRS stated, in the series of announcements concerning the TRAC program that were published in 2000, that employees who properly report tips would not be subject to challenge by the IRS. Notice 2000-21 was silent as to the tip examination impact on employees in the EmTRAC program.

In 2001, the IRS issued Announcement 2001-1, which finalized pro forma TRAC and TRDA agreements described in Announcements 2000-19 through 2000-23, and provided that the final versions would be available on http://www.irs.gov. In addition, the IRS issued Notice 2001-1 to supersede Notice 2000-21 and make several non-substantive clarifying changes to the EmTRAC program.

The TRAC, TRDA, and EmTRAC programs have continued largely unchanged and have had substantial participation. The TRAC agreements and TRDAs currently available on the Small Business/Self-Employed (SB/SE) Division webpage on http://www.irs.gov are similar to the agreements proposed in the series of announcements from 2000 and 2001. The EmTRAC program currently available on the SB/SE Division webpage on www.irs.gov is the program described in Notice 2001-1.

In Announcement 2012-25, 2012-26 I.R.B. 1054, the IRS stated that it planned to request public comment on possible changes to the existing TRD/EP. On April 29, 2013, the IRS issued Announcement 2013-29, 2013-18 I.R.B. 1024, soliciting comments on all aspects of TRACs and TRDAs and on ways to improve tip reporting compliance and utilize technological advancements to decrease the administrative burden on taxpayers and the IRS. In addition to providing a list of items to be updated, the IRS specifically solicited comments on the processes, computational methodologies, agreement language, and suggested topics for Frequently Asked Questions. Comments received by the IRS encouraged the use of a point-of-sale system (POS System) to track and improve tip reporting for both directly and indirectly tipped employees and requested that any changes to tip reporting compliance programs provide added flexibility to cover a wide range of business models. Commenters requested that any new agreement include incentives for employee. participation and clarify when the IRS may retroactively revoke a tip reporting agreement. Some commenters suggested that minimum tip rates should be established, and that consolidated reporting be available for all establishments located in the same facility. Commenters also requested that any new agreement be released with an additional opportunity for public comment.

SUMMARY OF PROPOSED REVENUE PROCEDURE

The proposed revenue procedure describes the SITCA program, which is a new voluntary tip reporting program being proposed by the National Tip Reporting Compliance Program (NTRCP) to replace the TRAC, TRDA, and EmTRAC programs. NTRCP is part of the Small Business/Self-Employed Division of the IRS. Under the proposed revenue procedure, the SITCA program is available to employers in all service industries (excluding gaming industry employers) with at least one business location, called a “Covered Establishment,” operating under the Employer Identification Number (EIN) of the employer. The SITCA program is designed to take advantage of advancements in POS Systems and time and attendance systems, as well as the use of electronic payment settlement methods to improve tip reporting compliance and to decrease taxpayer and IRS administrative burden. After acceptance into the SITCA program, an employer must annually establish that each of its participating Covered Establishments satisfies a minimum reported tips requirement with respect to its tipped employees in order for that Covered Establishment to continue with the program into the next year. If the employer cannot establish that a Covered Establishment meets this requirement with respect to a calendar year, the Covered Establishment will be removed from the program retroactively to the beginning of that calendar year and will not be eligible to participate in the SITCA program again for the immediately succeeding three completed calendar years or as otherwise provided by the IRS.

The proposed revenue procedure sets forth requirements for an employer to participate in the SITCA program. An eligible employer, called a “Service Industry Employer,” is generally an employer (excluding gaming industry employers) that (1) is in a service industry where employees perform services for customers and those services generate sales that are subject to tipping by customers, (2) has at least one Covered Establishment, and (3) is compliant with Federal, state, and local tax laws for the three completed calendar years immediately preceding the date the application is filed (the preceding period), plus the calendar quarters following the end of the preceding period through any calendar quarters during which the Service Industry Employer's application is pending for some or all of the quarter.⁴ After acceptance, Service Industry Employers must continue to satisfy these requirements to continue participating in the SITCA program.

The proposed revenue procedure also sets forth the requirements for each Covered Establishment to participate in the SITCA program. A Covered Establishment must have tipped employees who utilize a technology-based time and attendance system to report tips under section 6053(a). Each Covered Establishment must also utilize a POS System to record all sales subject to tipping, and that POS System must accept the same forms of electronic payment for tips as it does for sales. The IRS will accept employers and Covered Establishments into the SITCA program that meet the eligibility criteria if the IRS also determines, in its sole discretion, that acceptance is warranted by the facts and circumstances and is in the interest of sound tax administration.

Similar to the TRAC, TRDA, and EmTRAC programs, the proposed SITCA program will provide accepted employers with protection from section 3121(q) liability with respect to their Covered Establishments that remain in compliance with the program unless the liability is based on (1) tips received by a tipped employee where the asserted liability is based upon the final results of an audit or agreement of the tipped employee, or (2) the reporting of additional tip income by a tipped employee. The protection from section 3121(q) liability applies only to Service Industry Employers with Covered Establishments for the periods for which they have been approved to participate in the SITCA program. It does not apply to Service Industry Employers to the extent they have Covered Establishments that have been removed from the SITCA program, for the period of time between a Covered Establishment's removal and reinstatement (if applicable), or to the extent a Service Industry Employer has other business locations, either with tipped employees or without, that are not approved to participate in the SITCA program.

Service Industry Employer compliance is measured, in part, by satisfying a minimum reported tips requirement with respect to total tips reported for a calendar year by tipped employees at each Covered Establishment. In order for the Service Industry Employer to be compliant with respect to a Covered Establishment participating in the SITCA program, the tips reported by tipped employees at each Covered Establishment must meet or exceed the sum of (1) all charge tips, as established by the Covered Establishment's POS System, plus (2) an estimation of all cash tips calculated using charge tips and other data from the POS System and applying a minimum charge tip rate as well as applying discount rates for both stiffing and the differential between cash and charge tipping (cash tipping is typically lower). In calculating the annual estimated amount of all cash tips, the Covered Establishment will use three rates established by the IRS: the SITCA Minimum Charge Tip Percentage, the Cash Differential, and the Stiff Rate. The IRS will calculate these rates using tipping data it collects from service industry establishments though the TRDA program (until those agreements have ended), the GITCA program (especially gaming-related food and beverage establishments that participate in this program), and the SITCA program itself, once data from this program becomes available. These three rates will be specified on www.irs.gov and updated annually.⁵

For each calendar year in which the accepted employer demonstrates that a Covered Establishment has satisfied these and the other requirements of the proposed revenue procedure, the Service Industry Employer will receive protection from liability under section 3121(q) and the Covered Establishment may continue to participate in the SITCA program through the Service Industry Employer into the next calendar year.

The proposed revenue procedure requires Service Industry Employers to demonstrate compliance with the SITCA program by submitting an annual report on behalf of each Covered Establishment after the close of the calendar year. If the Service Industry Employer cannot establish that a Covered Establishment satisfied the minimum reported tips requirements in its annual report, the Service Industry Employer will not receive protection from liability under section 3121(q) with respect to that Covered Establishment for the calendar year to which the annual report applies and that Covered Establishment will be removed from the SITCA program. Once a Covered Establishment is removed from the SITCA program, it is generally eligible for reinstatement only after the Service Industry Employer can establish that it has satisfied the minimum reported tips requirement with respect to that Covered Establishment for three completed calendar years.

A study conducted by the Treasury Inspector General for Tax Administration (TIGTA) in 2018 concluded that the IRS was providing tip income audit protection to potentially noncompliant employers and employees.⁶ Using data from the TIGTA Data Center Warehouse's Business Returns Transaction File to review samples and analyze trends, TIGTA determined that 30 percent of the employers with tip reporting agreements that filed a Form 1120, U.S. Corporation Income Tax Return; Form 1120S, U.S. Income Tax Return for an S Corporation; or Form 1065, U.S. Return of Partnership Income, and Form 941, Employer's Quarterly Federal Tax Return, for the 2016 tax year had projected unreported tips totaling nearly $1.66 billion. One of the problems identified by TIGTA is that the IRS rarely revokes tip reporting agreements, resulting in continued tip income audit protection for noncompliant employers, and in some cases, their employees. TIGTA recommended that the IRS train its employees on specific criteria for revoking tip reporting agreements with noncompliant taxpayers.

In response to these concerns, the proposed SITCA program has several features designed to result in increased tip reporting compliance. The proposed SITCA program streamlines both compliance with and enforcement of tip reporting requirements by eliminating employee participation and the corresponding employee tip income audit protection and providing for automatic removal of a Covered Establishment that fails to satisfy SITCA's minimum reported tip requirement in its annual report. Unlike the GITCA and TRDA programs, the proposed SITCA program does not require any tax reporting commitment from employees. Employees are not required to report tips at an hourly rate, nor are employers required to provide educational or tip reporting training programs to their employees as is the case in the TRAC program. Employees have a responsibility to report actual tips received pursuant to section 6053(a), but employees do not sign participation agreements or otherwise agree to be monitored for compliance by their employers, as is the case in the GITCA and TRDA programs. Providing employee tip examination protection to employees without a measurable form of tip reporting compliance would not be in the interest of sound tax administration and would impose significant additional recordkeeping burdens on employers and the IRS to determine the eligibility of individual employees. Therefore, no tip examination protection is provided to employees under the proposed SITCA program. Because any Covered Establishments that do not meet the minimum reported tips requirement will be removed from the program, the IRS and Treasury view the SITCA program as providing employers with an incentive to train, educate, and implement procedures for employees to provide an accurate report of all tips received. More accurate tip reporting also benefits employees upon audit and can result in higher social security wages credited to them upon retirement.

The SITCA program is intended to serve as the sole tip reporting compliance program for employers in all service industries (excluding gaming industry employers). The proposed revenue procedure provides that for employers with existing agreements in the TRAC, TRDA and EmTRAC programs, there will be a transition period during which the existing agreements will remain in effect. The transition period will end upon the earliest of (1) the employer's acceptance into the SITCA program; (2) an IRS determination the employer is noncompliant with the terms of the TRAC, TRDA, or EmTRAC agreement; or (3) the end of the first calendar year beginning after the date on which the final revenue procedure is published in the Internal Revenue Bulletin. The proposed revenue procedure provides that employers participating in the TRAC, TRDA, and EmTRAC programs at the time the final revenue procedure is published in the Internal Revenue Bulletin will continue to have protection from section 3121(q) liability to the extent they are compliant with their existing tip reporting agreements prior to termination. Employees who have been receiving protection from tip income examination through their employer's participation in an existing TRAC, TRDA, or EmTRAC agreement will also continue to receive that protection for the return periods covered by their employer's agreement (including during the transition period) to the extent their employers remain compliant with the terms of their agreement.

REQUEST FOR COMMENTS

The IRS requests comments on all aspects of the proposed revenue procedure, and specifically requests comments on the following issues:

• How a technology-based time and attendance system may be used by tipped employees to report tips, including tips in cash and other forms of tipping made through electronic payments methods (other than a credit card), regardless of whether the tips are received directly from customers or through tip sharing arrangements;

• How tip sharing practices vary across service industries and how the SITCA program can support employer participation while accommodating potential differences in Federal, state, and local labor and employment law requirements;

• How employers of large food or beverage establishments participating in the SITCA program may meet their filing and reporting obligations under section 6053(c) and also satisfy the SITCA program requirements for compliance, while minimizing the administrative burdens on taxpayers and the IRS.

Comments must be received by May 7, 2023 and may be submitted in one of two ways:

CONTINUED APPLICATION OF ANNOUNCEMENT 2001-1 AND NOTICE 2001-1

Pending publication of the final revenue procedure in the Internal Revenue Bulletin, Announcement 2001-1 and Notice 2001-1 continue to apply with respect to participating employers. However, the IRS will not enter into any new TRAC, TRDA, or EmTRAC agreements with any employers that do not already have an agreement, as of March 8, 2023.

DRAFTING INFORMATION

The principal author of this notice is Stephanie Caden of the Office of the Associate Chief Counsel (Employee Benefits, Exempt Organizations, and Employment Taxes). For further information regarding this notice, contact Stephanie Caden at 202-317-4774 (not a toll-free number).