Regardless of what you call it, tips are amounts customers willingly determine and leave of their own accord; service charges are added to the bill. The difference, according to a new IRS revenue ruling, is that service charges are immediately taxable as wages; tips are taxable when employees report them to you.
The ruling makes these additional points:
- You aren’t liable to withhold and pay FICA taxes on employees’ unreported tips until you receive a Section 3121(q) Notice and Demand for the taxes from the IRS.
- You receive a Section 3121(q) Notice and Demand when you’re advised by the IRS, in writing, of the amount of employees’ unreported tips; there’s no specific form this notice must take.
- After a notice and demand is made, report the liability for FICA taxes on unreported tips as a current liability on Form 941 for the quarter in which the notice and demand is made. The IRS has until the later of three years after the due date of the 941 or the date the 941 was filed to assess the FICA taxes. (Rev. Rul. 2012-18, IRB 2012-26)