IRS Proposes New Program that will Disproportionately Crackdown on Small Business and the Working Class, i.e. the “Small Guys.”

Servers beware:

The IRS is taking a hard look at your tips!

Many working in the service industry, who make minimum wage, survive on their tips. What are tips? The IRS explains that tips are “optional cash or noncash payments that customers make to employees.” The IRS has four factors that determine whether or not a payment is considered a tip: 1) the payment is non-compulsory, 2) the customer decides the amount, 3) the payment is not regulated by the employers, and 4) the customer decides who gets the payment. If all four factors are satisfied, the payment is a tip. It must be reported and is taxable.

For service industry employees, the IRS requires them to maintain records of tips they receive on a daily basis, and they must report their tips to their employers by the 10th of the month- if the employees’ tips exceed more than $20 per month. Seeing how we are now tipping for nearly every service, including a (“to-go”) cup of coffee, you can imagine that $20 a month is a very low threshold. The employees must then report all those tips on their individual tax returns. As you can imagine, tip reporting (especially for those tips left in cash) is mostly based on the honor system and can be a point of contention between both the employer and the service industry employee.

This past Monday, February 6, 2023, the IRS announced that it is proposing a new program that would allow digital tracking of all service employees’ tips. The IRS’s proposed new program called The Service Industry Tip Compliance Agreement (SITCA) is completely optional but provides some perks to employers that may make enrolling in this program desirable to employers. This new SITCA program is meant to replace the three existing tip reporting programs currently used by the IRS: the Tip Rate Determination Agreement (TRDA), the Tip Reporting Alternative Commitment (TRAC), and Employer signed TRAC (EmTRAC).

What’s the catch? How will the IRS accomplish this? Well, the IRS will grant the employers liability protection from 26 C.F.R. §31.3121(q) and flexibility in how the employers implement their own tip reporting policies. In exchange for the liability protection and flexibility, the employers will allow the IRS to monitor the employer’s business electronically- through the employer’s own electronic records. In other words, the IRS will ensure the employer’s compliance through the employer’s actual annual tip revenue, the charge tip data from the employer’s point-of-sale (“POS”) system, and allowance for adjustments in tipping practices from year to year. In addition, the employers can submit annual reports, which will reduce the IRS’s workload because the IRS will have less need to conduct compliance reviews. The program basically tracks compliance based on the transactions made on the employer’s debit or credit card machine or cash register.

Some employers will be highly motivated by the liability protection to comply with SITCA. After the employer is accepted into the SITCA program, the employer must show that “it satisfies a minimum reported tips requirement with respect to its tipped employees” in order to continue in the SITCA program the following year. To be compliant, the IRS states that the tips reported by tipped employees “must meet or exceed the sum of (1) all charge tips, as established by the ...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).” The penalty for not being in compliance with SITCA requirements is quite hefty: employers may find themselves automatically removed from the SITCA program and prevented from re-enrolling for the next three years.

Clearly, the burden of meeting the minimum reported tips requirement will cause many employers to crackdown on employees to be meticulous in reporting tips- no matter how small the tip is and especially if the tips are made in cash. These employees are already making a lower wage than many other industries. Now, they will be saddled with ongoing monitoring to ensure compliance with the SITCA program’s minimum reported tips requirement. The IRS’s newly proposed SITCA program is the beginning of a new era: one where transactions, even the smallest transactions for a cup of coffee, can trigger tax liability.