In the past, the IRS performed examinations on the returns of tipped employees and determined that a large number of these employees were not properly reporting their tips. Significant tax deficiencies often result from these
examinations. These examinations created significant burdens not just for the employees and the employer, but also for the IRS. The IRS began to explore new methods to achieve voluntary compliance and at the same time reduce the burden for all parties concerned. These efforts resulted in the IRS tip compliance
program, The Tip Rate Determination and Education Program (“TRD/EP”) was introduced in October 1993.
The TRD/EP introduced a nontraditional approach in an important area of
noncompliance. The program is intended to increase employees’ reporting of tips to their employers by means of customer outreach and education rather than by traditional enforcement methods. The program involves execution of an agreement, either a TRDA or TRAC, between the business owner and the IRS. Both the employer and IRS agree to certain terms under these agreements. A TRDA is available for the food and beverage industry, and there is one
specifically for the Gaming (casino) industry. TRAC is available to employers in the food and beverage industry, and there is one specifically for the Cosmetology and Barbering Industry. Recently, new TRAC and TRDA agreements were released for public comments. Other industries where tipping is customary now may participate in this highly successful program. Copies of TRDAs and TRACs can be accessed from the IRS web site at www.irs.gov.
Participation in either a TRDA or TRAC is entirely voluntary. Section 3414 of the IRS Restructuring and Reform Act of 1998 prohibits IRS from threatening to audit any taxpayer to coerce the taxpayer into entering into a TRAC agreement. No representative of the Service should threaten an audit when meeting with a taxpayer to solicit participation in either agreement. However, you should consider a tip examination if a taxpayer does not sign up for either of the two agreements, does not take any action to increase compliance, and there is sufficient evidence of significant underreporting of tip income. IRS policy
requires an interval of at least 6 months from the date of the initial contact and the beginning of a Tip examination. If there are subsequent contacts, then the IRS should wait 6 months from the last contact to solicit an agreement before beginning aTip examination.
The IRS identifies restaurants that may have unreported tips by analyzing the annual Form 8027 required of each establishment meeting the filing requirements. The analysis identifies discrepancies between the charged tip rate and the reported tip rate. This information is then used to prioritize the establishments by greatest discrepancy. Determining the correct amount of tip income earned by tipped employees is difficult. In the absence of accurate records, an indirect method for determining the correct tip income, referred to as the McQuatter’s Formula, has often been applied for these situations, as discussed later.
Refer to Chapter 7 of IRM 104.6, Employment Tax Handbook, for more information on the TRD/EP and on tip examination procedures, as well as on Form 8027. Examiners need to contact their local Employment Tax group for the most current policy and procedures related to tip examinations. A tip training guide is also available that provides more details on this program and audit procedures for performing tip examinations. At the time of finalizing this guide, the tip training guide was in the process of being revised. The training guide is currently being rewritten and will be available soon.
Notice 2001-2, 2001-2 I.R.B. 261, discusses the Employer Tip Reporting
Alternative Commitment program (“EmTRAC”). This program allows for food and beverage employers to prepare their own tip reporting program and receive IRS approval as long as they agree to:
1. Comply with the requirements for filing all required federal tax returns and paying and depositing all federal taxes
2. Maintain the following records for at least 4 years after the April 15 following the calendar year to which the records relate:
a. gross receipts subject to tipping, and b. charge receipts showing charged tips
3. Upon the taxpayer's request, make the following quarterly totals available, by establishment, for statistical samplings:
a. gross receipts subject to tipping, b. charge receipts showing charged tips c. total charged tips, and
d. total tips reported
4. Operate its EmTRAC program as indicated in the program documents in the announcements.
5. Comply with the terms of the IRS approval described in Notice 2001-2. IRS approval includes the following commitments on the part of the IRS: · The Service agrees not to initiate any new tip examinations of the taxpayer
for any of the establishments included in the taxpayer's letter for any period during which the taxpayer's EmTRAC program is in effect.
· Any IRC section 3121(q) notice and demand relating to any period during which the EmTRAC program is in effect will be based solely on amounts reflected on Form 4137, Social Security and Medicare Tax on Unreported Tip Income, filed by an employee with his or her Form 1040, or Form 885- T, Adjustment of Social Security Tax on Tip Income Not Reported to
Employer, prepared at the conclusion of an employee tip examination.
· The Service will not evaluate the EmTRAC program until the second quarter following the date of the letter. The Service can review the progress in implementing the EmTRAC program before then.
· The EmTRAC program will remain in effect until the taxpayer or the IRS terminates it. The Service can terminate the program only:
1. If the taxpayer fails to comply with the agreement described in the letter
2. If the Service pursues an administrative or judicial action relating to the taxpayer, an establishment, or any other related party to the taxpayer's EmTRAC program.
3. Following a significant statutory change in the FICA taxation of tips, or
4. After May 31, 2005
· Any termination will be effective the first day of the first calendar quarter after the terminating party notifies the other party in writing, unless the taxpayer fails to comply with the agreement. In that case, the Service may terminate the EmTRAC program effective as of the first day of the quarter in which the taxpayer ceased to comply.
Requests for approval must be sent by taxpayers to: Internal Revenue Service
OP: EX: ST: ET Room 2404 Attn: EmTRAC Coordinator 1111 Constitution Avenue N.W. Washington, D.C. 20224