The Internal Revenue Service recently released administrative guidelines for employers and employees in a question and answer format concerning Rev. Rul. 2012-18, published in the 2012-26 Internal Revenue Bulletin, which affirm the factors used to determine whether earnings should be characterized as tips or as service charges.
The IRS is aware that some businesses may have to change automated or manual reporting systems in order to comply with the proper treatment of service charges as specified in A&A 1 of Rev. Rul 2012-18. Starting in 2013, any payments made as a service charge, rather than as a tip, should be considered wages for reporting and taxation purposes. The absence of any of the following factors indicates that a payment is most likely a service charge rather than a tip, and should be reported as regular wages:
- The payment must be made free from compulsion;
- The customer must have the unrestricted right to determine the amount;
- The payment should not be subject of negotiation or dictated by employer policy; and,
- Generally the customer has the right to determine who receives the payment.
The changes in service charges being included as regular wages causes several reporting changes:
- Service charges would be reported in Box 3 of the Form W-2 as Social Security wages; and, not in Box 7 as Social Security Tips;
- Service charges will no longer be included in the calculation of allocated tips; and,
- On the Form 941, Service Charges would be included in the amount entered on line 5a, column 1; rather than on line 5b, column 1 for Social Security Reporting.