Amounts Deposited in Tip Jars Were Unreported Tips Not Subject to Withholding

The IRS has ruled that amounts placed in “tip jars” at stores owned by the taxpayer were considered to be tips governed by Code Sec. 3121 (q), rather than wages subject to FICA withholding. As a result, the amounts deposited in the tip jars would not be subject to the employer share of FICA tax until the IRS files a notice and demand for the taxes from the taxpayer (CCA 200929004).

The taxpayer was a corporation engaged to retail sales of produce and related items. The nature of the business was such that customers often provided additional amounts as compensation was generally viewed as tips for those persons. The taxpayer’s policy was to have a specified container placed near a cash register to serve as a “tip jar” for collecting cash amounts left by the customers. The jars could not be used to make change, and the amounts deposited in the jars were not designed for any particular employee.

At the end of each business day, the amounts deposited in the tip jars were counted, logged , and stored in the company safe. The tip jar amounts were later distributed to non-managerial employees (even though some managers also participated in serving customers). There were no restrictions placed on the amount that could be paid out to employees. The tip jar amounts were distributed weekly. The amount of “tipable” hours worked by each employee was calculated each week and the appropriate amount of tips was then transferred to the employee.

Tax under the Federal Insurance Contributions Act (FICA) is imposed by Code Secs. 3101 and 3111 on wages, as that term is defined in Code Sec. 3121 (a). The statute excludes from the definition of wages all non-cash tips, and all cash tips unless the amount of cash tips is $20 or more.

An employer is ordinarily required to withhold and pay over the employee portion of the FICA tax. However, that withholding requirement applies only to tips that are included in a written statement furnished to the employer (Form 4070) , and only to the extent that collection can be made by the employer by deducting the amount of the tax from wages paid to the employee, including tips. An employer is required to deduct and withhold the tax on the tips constituting wages only for those tips the employee reports to the employer in a written statement.

Tips received by an employee are generally considered to be remuneration for employment, and the employer is considered to have paid them over for FICA purposes, when a written statement including the tips is furnished by the employee to the employer (Form 4070). If the tips are not reported, or the reporting is incomplete or inaccurate, the tips are considered to be paid on the date that the IRS makes notice and demand for the taxes to the employer.

Amounts received by employees are only considered to be “tips” if the contributions by the customers were made free from all compulsion, the customer had the unrestricted right to determine the amount, and the contributions were not subject to negotiation or dictated by company policy. Essentially, the customer has the right to determine who precisely will receive the contribution. In the absence of any of these elements, the payment is probably not a tip, but is more likely a service charge for the use of certain facilities. In this case, the amounts placed in the tip jar retained their character as tips governed by Code Sec. 3121 (a). As a result, the unreported tips would not be subject to the employer share of FICA tax until the IRS made notice and demand for the taxes from the employer.