Rules distinguishing tips from service charges delayed until 2014

In Announcement 2012-50, the IRS announced that businesses have additional time to make the changes needed to comply with the proper treatment of tips and service charges under Q&A-1 of Rev. Rul. 2012-18. Announcement 2012-25 previously delayed implementation to amounts paid on or after Jan. 1, 2013, and requested comments about whether additional time was needed. Thursday’s announcement, which was issued in response to comments the IRS received that more time was needed, extends the time for compliance to amounts paid on or after Jan. 1, 2014. 

Rev. Rul. 2012-18 provides question-and-answer guidance for distinguishing between tips and service charges for purposes of FICA tax, the credit under Sec. 45B for the excess employer Social Security tax an employer pays on tips, and the rules for employer reporting of tips under the notice and demand provisions of Sec. 3121(q). Service charges are characterized as wages for FICA tax purposes.

To determine whether a payment is a tip or a service charge, the IRS cites in Q&A-1 the factors from Rev. Rul. 59-252. To be a tip:

• The payment must be free from compulsion;
• The customer must be able to determine the amount of the payment without restriction;
• The payment cannot be negotiable or dictated by the employer; and
• The customer should generally have the right to decide who receives the payment.

If any of the above factors is missing, there is doubt that the payment is a tip. Nonetheless, all of the surrounding circumstances must be considered. Rev. Rul. 2012-18 contains an example illuminating the distinction: A restaurant policy of automatically adding an 18% charge to the bill of parties of six or more is a service charge, but where a bill shows sample calculations of different tip amounts (e.g., 15%, 18%, or 20%), and the actual tip line is left blank by the restaurant, if the customer puts an amount on the tip line, it is a tip.

According to an Interim Guidance Memorandum (IGM) issued on June 7, 2012 (SBSE-04-0612-057), Rev. Rul. 2012-18 was intended to be effective immediately and retroactively. However, because the tip vs. service charge part of the ruling described above may require businesses to change their business practices and make system changes to comply, the IRS announced that its examiners were being instructed, in limited circumstances, to apply the rules prospectively to amounts paid on or after Jan. 1, 2013. As noted above, these deadlines are now delayed further, so they will apply to amounts paid on or after Jan. 1, 2014. An updated IGM will be issued informing examiners of the additional extension.

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.