Tips vs Service Charges: An IRS Reminder

The IRS wants to make sure that employers understand tax ramifications of the various payments that they make to employees or that their employees might receive.  So the IRS has posted a reminder for employers when it comes to tips verses service charges.  The key difference between the two categories affect the taxation for employees as well as the reporting. So-called “automatic gratuities” and any amount imposed on the customer by the employer are service charges, not tips.  Service charges are generally wages, and they are reported to the employee and the IRS in a manner similar to other wages. On the other hand, special rules apply to both employers and employees for reporting tips. Employers should make sure they know the difference and how they report each to the IRS.

What are tips? Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers. They include:

  • Cash tips received directly from customers.
  • Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
  • The value of any noncash tips, such as tickets, or other items of value.
  • Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangements.

Four factors are used to determine whether a payment qualifies as a tip. Normally, all four must apply. To be a tip:

  • The payment must be made free from compulsion;
  • The customer must have the unrestricted right to determine the amount;
  • The payment should not be the subject of negotiations or dictated by employer policy; and
  • Generally, the customer has the right to determine who receives the payment.

If any one of these doesn’t apply, the payment is likely a service charge.

What are service charges? Amounts an employer requires a customer to pay are service charges. This is true even if the employer or employee calls the payment a tip or gratuity. Examples of service charges commonly added to a customer’s check include:

  • Large dining party automatic gratuity
  • Banquet event fee
  • Cruise trip package fee
  • Hotel room service charge
  • Bottle service charge (nightclubs, restaurants)

Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages to those employees.

All cash tips and noncash tips should be included in an employee’s gross income and subject to federal income taxes.ployers are required to retain employee tip reports, withhold income taxes and the employee share of Social Security and Medicare taxes from the wages paid, and withhold income taxes and the employee share of Social Security and Medicare taxes on reported tips from wages (other than tips) or from other funds provided by the employee. In addition, employers are required to pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as the reported tip income.  Employers must report income tax and Social Security and Medicare taxes withheld from their employees’ wages, along with the employer share of Social Security and Medicare taxes, on Form 941, Employer’s Quarterly Federal Tax Return, and deposit these taxes in accordance with federal tax deposit requirements.Tips reported to the employer by the employee must be included in Box 1 (Wages, tips, other compensation), Box 5 (Medicare wages and tips), and Box 7 (Social Security tips) of the employee’s Form W-2, Wage and Tax Statement. Enter the amount of any uncollected social security tax and Medicare tax in Box 12 of Form W-2. See the General Instructions for Forms W-2 and W-3.

Reporting Service Charges: Employers who distribute service charges to employees should treat them the same as regular wages for tax withholding and filing requirements, as provided in Publication 15, Employer’s Tax Guide. Distributed service charges must be included in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages and tips) of the employee’s Form W-2.

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MA Governor Proposes Reinstating “Fair-Share” Assessment

Massachusetts Governor Charlie Baker included a plan to reinstate the “fair-share contribution” formerly assessed against employers without a health insurance plan in his fiscal year 2018 budget.  The assessment would recommence as of January 1, 2018 if passed.  They are intended to partially cover the $600 million shortfall in the state healthcare system (Mass Health) for low-income residents. The fair-share contributions were repealed in 2013 with the advent of the Affordable Care Act.   For more detailed information check out the Associated Industries of Massachusetts blog. 

 

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Get Your Opinion Heard on Form W-2

The IRS is required, as part of its continuing effort to reduce paperwork (pause for giggles from Payroll Professionals) to invite the public to comment on either proposed or continuing information collections.  This is all part of the Paperwork Reduction Act of 1995.  This time around it is forms we all know and love.  The IRS is currently taking comments the following forms: W-2, W-2c, W-2A, W-2GU, W-2VI, W-3, W-3c, W-3cPR, W-3PR, and W-3SS.

They want to know how to improve the form so it is less burdensome. One area that immediately comes to mind is the lack of space for reporting the Additional Medicare Tax. In my opinion it would be better to have a separate box for the wages and the taxes. Just a reminder that box 9 is already taken as of 2017 so you can’t suggest using that box for anything.   You need to submit your comments directly to the IRS. They accept comments from any user so you don’t have to be an “accounting firm” or a “law firm”.  They want to hear from users. Written comments must be received on or before December 12, 2016 to be assured of consideration.  Written comments are directed to:

Tuawana Pinkston, Internal Revenue Service, Room 6526, 1111 Constitution Avenue NW, Washington, DC 20224

Requests for additional information or copies of the collection tools should be directed to Sara Covington, Internal Revenue Service, Room 6526, 1111 Constitution Avenue NW., Washington, DC 20224, or through the internet at Sara.L.Covington@irs.gov.

 

Update on Multistate Taxation Legislation–Passed the House Again! But Needs Your Help

In our blog on March 9th of this year we discussed the latest attempt (the last one was 2012) to simplify taxation for multistate employees.  Those are employees who live in one state and work in other states. Many of these employees work in the state for only a few days or weeks out of the calendar tax year, yet employers must withhold taxes for these states and the employees must file, in most cases, income tax returns.  To try to alleviate this burden on employers ( the tracking requirements for payroll departments can be massive) the Mobile Workforce State Income Tax Simplification Act of 2015 (H.R. 2315 ) was introduced.  A major push by payroll professionals and the American Payroll Association was begun. I, myself, wrote letters to the Nevada congress members and Senators asking for the bill to be passed as well as asked my blog followers to do the same.  Well the hard work so far is paying off.  The House of Representatives passed the bill on September 21st and it is now in the hands of the Senate.  It appears to be a bi-partisan bill with co-sponsors from both sides of the aisle. However, a similar bill was passed in 2012 but was not considered by the Senate before they adjourned the session so this may be the case this year.  It is opposed by New York state and similarly situation states that will lose a lot of revenue from nonresidents if the bill is passed. Let’s keep our fingers crossed.  However, writing to your Senators might help push this along. If every payroll professional who has had to deal with tracking, withholding and paying multistate employees would write a letter to their own Senators imagine how flooded the Senate mail office would be! So write, phone or email your Senators today!

IRS Begins Private Debt Collection in Spring 2017

The Internal Revenue Service announced today that it plans to begin private collection of certain overdue federal tax debts next spring and has selected four contractors to implement the new program. The new program, authorized under a federal law enacted by Congress last December, enables these designated contractors to collect, on the government’s behalf, outstanding inactive tax receivables. As a condition of receiving a contract, these agencies must respect taxpayer rights including, among other things, abiding by the consumer protection provisions of the Fair Debt Collection Practices Act. The IRS has selected the following contractors to carry out this program:

CBE Group 1309 Technology Pkwy Cedar Falls, IA 50613

Conserve 200 CrossKeys Office park Fairport, NY 14450

Performant 333 N Canyons Pkwy Livermore, CA 94551

Pioneer 325 Daniel Zenker Dr Horseheads, NY 14845

These private collection agencies will work on accounts where taxpayers owe money, but the IRS is no longer actively working their accounts. Several factors contribute to the IRS assigning these accounts to private collection agencies, including older, overdue tax accounts or lack of resources preventing the IRS from working the cases. The IRS will give each taxpayer and their representative written notice that their account is being transferred to a private collection agency. The agency will then send a second, separate letter to the taxpayer and their representative confirming this transfer. Private collection agencies will be able to identify themselves as contractors of the IRS collecting taxes. Employees of these collection agencies must follow the provisions of the Fair Debt Collection Practices Act and must be courteous and respect taxpayer rights.

sale-red-keyATTENTION BLOG FOLLOWERS!: To reward my blog followers I am offering a special discount on a year’s subscription to The Payroll Pause.  Only $99 per year (rate lasts as long as you keep your subscription current).  That is a $50 savings!  But act fast as this discount is just for the fall and will expire on October 15th.  Use coupon code X36AK67F3 when checking out to receive the discount.

White Paper for the Month: Educational Assistance

My white paper for September is on educational assistance.  How to properly track and tax this benefit is paramount to ensure compliance.  Hope you find it useful.

white-paper-educational-assistance-2016

Beginning in October we will go back to more frequent white papers.  We do them monthly during the summer as it is usually a slow time of the year for payroll and we all want to enjoy the summer off.  But as year end begins to approach we will be focusing our white papers on preparing for it.

Speaking of year end…don’t get left out in the cold when it comes to critical year end news updates. Subscribe to The Payroll Pause today. Get all the latest payroll news as it is released, including wage bases, rates, and annual updates for the low price of only $149 per year.  This type of news update service usually costs payroll departments $500 or more per year.  But payroll news should not be out of the reach of all payroll professionals.

sale-red-key

 

ATTENTION BLOG FOLLOWERS!: To reward my blog followers I am offering a special discount on a year’s subscription to The Payroll Pause.  Only $99 per year (rate lasts as long as you keep your subscription current).  That is a $50 savings!  But act fast as this discount is just for the fall and will expire on October 15th.  Use coupon code X36AK67F3 when checking out to receive the discount.

White Paper: Disaster Payments and the IRS

We are always hearing in the news about the latest disaster in the nation. Whether it be wild fires in California or flooding in Texas. Natural disasters do happen and can be annual occurrences in some parts of the nation.  When this happens, it is natural to want to help those individuals who are personally affected especially if it strikes close to home like in the case of a co-worker.  When a co-worker loses a home to a wild fire or must move out due to flood damage even employers want to help out.  But when an employer wants to help, does that change the nature of the disaster grantassistance. In other words,  if co-workers take up a collection it is one thing, but what if the employer gives the employee a grant to help cover the costs not reimbursed by insurance? Is it then taxable income and taxes must be deducted? Actually, it may not have to be. Our white paper this time is on Handling Disaster Relief Payments in Payroll.  It explains how and when these types of payments can be made and the taxation requirements.  We hope you find it useful.

white paper disaster payments 2016

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