Service Fee v. Tip - IRS Guidance to Examiners - John R. Dundon II, Enrolled Agent
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Service Fee v. Tip – IRS Guidance to Examiners

Business Entity Selection and the Tax Consequences of Converting

Service Fee v. Tip – IRS Guidance to Examiners

According to IRS administrative guidelines to its examiners concerning Rev. Rul. 2012-18, published in the 2012-26 Internal Revenue Bulletin, when performing a tip examination (aka audit), IRS examiners must ensure that service fees or charges are properly characterized as wages and not tips. If the payment is not a tip then it is a service charge and reported as wages.

Whether payments should be reported as tips or service charges basically distills down to whether the following factors were present:

(1) The payment was made free from compulsion;
(2) The customer had the unrestricted right to determine amount;
(3) The payment was not be the subject of negotiation or dictated by employer policy; and
(4) The customer determined who receives the payment.

Automatic gratuities (for parties of a certain size for example) should according to this directive to examiners be reported as service charges and not tips in my humble opinion. Comments on the interim guidance may be submitted either electronically at or in writing to:

Internal Revenue Service
National Tip Reporting Compliance
3251 North Evergreen Dr. NE
Grand Rapids, MI 49525

Also I learned that the IRS intends to solicit public comments on proposed changes to it’s existing voluntary tip compliance agreements.  Specifically, the Tip Reporting Alternative Commitment (TRAC) program and other variations of TRAC agreements.

The principal author of this revenue ruling is Linda L. Conway-Hataloski of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities).  For further information regarding this revenue ruling, contact Linda L. Conway-Hataloski at 202-622-0047.