A closer look at the IRS’s new tip reporting initiative
The IRS’s proposed program for ensuring the tips earned by taxpayers working in the service industry are correctly reported has received a great deal of media attention, but few news outlets have looked at the impact the proposed program would have on participating employers. In the sections that follow, we will look at the specifics of the Service Industry Tip Compliance Agreement (SITCA) program that are outlined in Notice 2023-13, explain how the agreements would operate and the potential benefits to employers who choose to participate.
According to the IRS, the SITCA program would take advantage of improvements in electronic payment settlement methods as well as advancements in point-of-sale (POS), time and attendance systems that have occurred since the agency began working with employers to improve tip reporting during the 1990s. Just like with the current programs, employers who participate in SITCA program receive protection from liability under the rules that define tips as part of an employee’s pay for the years they are compliant.
The SITCA program is intended to serve as the IRS’s sole tip reporting compliance program for service industry employers not operating in the gaming industry. For employers currently participating in voluntary tip reporting programs, there will be a transition period during which the existing agreements remain in effect.
SITCA would replace three existing programs
Notice 2023-13 includes the proposed revenue procedure describing the voluntary SITCA program proposed by the IRS’s National Tip Reporting Compliance Program, which is part of the Small Business/Self-Employed Division. The SITCA program would be available to all employers in the service industries, except for those in the gaming industry. The proposed program would replace three voluntary tip reporting programs the IRS has been operating:
- Tip rate determination agreements (TRDAs)
- Tip reporting alternative commitments (TRACs)
- Employer-designed tip reporting alternative commitments (EmTRACs)
Employers participating in the SITCA program would need to have at least one business location — known as a “covered establishment” — that operates under their employer identification number (EIN).
After being accepted into the program, the employer would need to establish that each of its covered establishments satisfies a minimum reported tips requirement with respect to its tipped employees to continue with the program into the next year. Employers unable to show that their covered establishment meets those requirements will be removed from the program retroactive to the beginning of the calendar year. The employer also would be ineligible to participate in the SITCA program for the next three calendar years, or until the IRS determines that they are again eligible.
No employee participation, protections
The IRS says the proposed SITCA program has several features that should improve tip compliance over the current reporting programs that are in place. According to the IRS, one of the ways the SITCA program would do that would be by eliminating employee participation in the program and the employee tip income audit protections participants currently receive. It would also automatically remove any covered establishment that fails to meet SITCA’s minimum reported tip requirements.
The revenue procedure states that providing employees with protection from the IRS’s examination of their tips without a measurable form of tip reporting compliance is not in the agency’s best interests and would impose significant additional recordkeeping burdens on employers and the IRS. Therefore, the IRS says it would not provide tip examination protection to employees under the proposed SITCA program.
Additionally, by removing covered establishments that don’t meet the SITCA program’s minimum tip reporting requirements, the program would provide employers with an incentive to train, educate and implement procedures for employees to accurately report the tips they receive. More accurate tip reporting would also benefit employees when they are audited and can result in them having higher reported Social Security wages credited to them upon retirement.
Which employers would be eligible?
The revenue procedure says that service industry employers that are eligible to participate in the SITCA program must generally meet the following requirements:
- Operate in a service industry where employees perform services for customers that generate tips from sales
- Have at least one covered establishment
Comply with federal, state and local tax laws for the three calendar years immediately preceding the date the application is filed, plus the calendar quarters following the end of the preceding period through any calendar quarters during which the employer’s application is pending for some or all of the quarter
Once they have been accepted, employers must continue to comply with these requirements to continue participating in the SITCA program.
In addition to the obligations for service industry employers, each covered establishment must also comply with specific requirements to participate in the SITCA program. The covered establishment must:
- Have tipped employees who utilize a technology-based time and attendance system to report tips
- Utilize a POS system to record all sales subject to tipping
- Use a POS system that accepts the same forms of electronic payments for tips as for sales
The IRS may also accept covered establishments if the agency determines that acceptance is warranted by the facts and circumstances of the establishment’s situation, and it is in the interest of sound tax administration.
Limits to employer liability protection
Similar to the current TRAC, TRDA and EmTRAC programs, the SITCA program would offer accepted employers with protection from §3121(q) liability with respect to covered establishments that remain in compliance unless the liability is based on:
- Tips received by an employee where the claimed liability is based on the final results of an audit or agreement of the tipped employee
- The reporting of additional tip income by a tipped employee
The employers’ protection from liability only applies to periods when they have been approved to participate in the SITCA program and does not apply after a covered establishment has been removed.
Annual reports will be required
Service industry employers will demonstrate their compliance with the SITCA program by submitting an annual report on behalf of each of their covered establishments after the close of the calendar year. If the service industry employer can’t establish that a covered establishment satisfied the minimum reported tips requirement in an employer’s annual report, it will not receive protection under S3121(q) with respect to that covered establishment for that year and will be removed from the SITCA program. Once removed, a covered establishment will only be eligible for reinstatement after the employer can establish that it has satisfied the minimum reported tips requirement with respect to the covered establishment for three completed calendar years.