rr-12-18.pdf

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing.

This collection currently includes the publisher’s available advance-release directory. Historical bulletin renditions are discovered separately; an advance-release record alone does not certify the collection archive complete.

Section 3121—Tips Included for Both Employee and Employer Taxes

Rev. Rul. 2012-18
The purpose of this revenue ruling is to clarify and update guidelines first
presented in Rev. Rul. 95-7, 1995-1 C.B. 185, concerning the taxes imposed on tips
under the Federal Insurance Contributions Act (FICA) and the notice and demand under
section 3121(q) of the Internal Revenue Code (Code).
Sections 3101 and 3111 of the Code impose FICA taxes on employees and
employers, respectively, equal to a percentage of the wages received by an individual
with respect to employment. FICA taxes consist of two separate taxes, the Old Age,
Survivors, and Disability Insurance (social security) tax and the Hospital Insurance
(Medicare) tax. The amount of wages subject to social security tax is limited by an
annual contribution and benefit base; however, all wages are subject to Medicare tax.
Section 3121(a) of the Code defines “wages” for FICA tax purposes as all
remuneration for employment, with certain exceptions. Section 3121(a)(12)(A) excludes
from the definition of wages tips paid in any medium other than cash; section
3121(a)(12)(B) excludes cash tips received by an employee in any calendar month in
the course of the employee's employment by an employer unless the amount of the
cash tips is $20 or more.
Employer FICA Obligations. Under section 3121(q) of the Code, tips received by
an employee in the course of the employee's employment are considered remuneration
for that employment and are deemed to have been paid by the employer for purposes of
the employer share of FICA taxes imposed by sections 3111(a) and (b), that is, social

1

security tax and Medicare tax, respectively. The remuneration is deemed to be paid
when a written statement including the tips is furnished to the employer by the
employee pursuant to section 6053(a), discussed below.
Section 3111 of the Code requires the employer to pay social security tax on the
amount of cash tips received by the employee up to and including the contribution and
benefit base as determined under section 3121(a)(1) and to pay Medicare tax on the
total amount of cash tips received by the employee. However, if the employee either
did not furnish the statement pursuant to section 6053(a) or if the statement furnished
was inaccurate or incomplete, in determining the employer's liability in connection with
the taxes imposed by section 3111 with respect to the tips, section 3121(q) provides
that the remuneration is deemed, for purposes of subtitle F (Procedure and
Administration), to be paid on the date on which notice and demand for the taxes is
made to the employer by the Internal Revenue Service (Service).
Employee FICA Obligations. Under section 3121(q) of the Code, for purposes of
the employee share of FICA taxes imposed by sections 3101(a) and (b), tips that are
properly reported to the employer pursuant to section 6053(a) are deemed to be paid at
the time a written statement is furnished to the employer pursuant to section 6053(a).
Unreported tips received by the employee are deemed to be paid to the employee when
actually received by the employee.
Section 6053(a) of the Code requires every employee who, in the course of the
employee's employment by an employer, receives in any calendar month tips that are
wages (as defined in section 3121(a) for FICA tax purposes or section 3401(a) for
income tax withholding purposes) to report all those tips in one or more written

2

statements furnished to the employer on or before the 10th day of the following month.
The employee is to furnish the statements in the form and manner prescribed by the
Service. See § 31.6053-1(b) of the Employment Tax Regulations.
Credit for Employer Share of FICA Taxes Paid. Section 45B(a) of the Code
provides that, for purposes of the general business credit under section 38, the credit for
employer social security and Medicare taxes paid on certain employee tips is an amount
equal to the "excess employer social security tax" paid or incurred by the employer.
The term "excess employer social security tax" means any tax paid by an employer
under section 3111 (both social security tax and Medicare tax) on its employees' tip
income without regard to whether the employees reported the tips to the employer
pursuant to section 6053(a). Consequently, the section 45B credit is available with
respect to unreported tips in an amount equal to the "excess employer social security
tax" paid or incurred by the employer. No credit, however, is allowed to the extent tips
are used to meet the federal minimum wage rate. For purposes of this limitation, the
federal minimum wage rate is the rate that was in effect on January 1, 2007. The credit
is available with respect to FICA taxes paid on tips received from customers in
connection with the providing, delivering, or serving of food or beverages for
consumption, if it is customary for customers to tip the employees.
QUESTIONS AND ANSWERS
IN GENERAL
Q1. Is the characterization of a payment as a “tip” by the employer determinative for
FICA tax purposes under section 3121 of the Code?

3

A1. No. The employer’s characterization of a payment as a “tip” is not
determinative. For example, an employer may characterize a payment as a tip, when in
fact the payment is a service charge. The criteria of Rev. Rul. 59-252, 1959-2 C.B. 215,
should be applied to determine whether a payment made in the course of employment
is a tip or non-tip wages under section 3121 of the Code. The revenue ruling provides
that the absence of any of the following factors creates a doubt as to whether a
payment is a tip and indicates that the payment may be a service charge: (1) the
payment must be made free from compulsion; (2) the customer must have the
unrestricted right to determine the amount; (3) the payment should not be the subject of
negotiation or dictated by employer policy; and (4) generally, the customer has the right
to determine who receives the payment. All of the surrounding facts and circumstances
must be considered. For example, Rev. Rul. 59-252 holds that the payment of a fixed
charge imposed by a banquet hall that is distributed to the employees who render
services (e.g., waiter, busser, and bartender) is a service charge and not a tip. Thus, to
the extent any portion of a service charge paid by a customer is distributed to an
employee it is wages for FICA tax purposes.
The application of the factors is illustrated by the following two common examples:
Example A: Restaurant W’s menu specifies that an 18% charge will be added to all
bills for parties of 6 or more customers. Customer D’s bill for food and beverages for
her party of 8 includes an amount on the “tip line” equal to 18% of the price for food and
beverages and the total includes this amount. Restaurant W distributes this amount to
the waitresses and bussers. Under these circumstances, Customer D did not have the
unrestricted right to determine the amount of the payment because it was dictated by

4

employer policy. Customer D did not make the payment free from compulsion. The
18% charge is not a tip within the meaning of section 3121 of the Code. The amount
included on the tip line is a service charge dictated by Restaurant W.
Example B: Restaurant X includes sample calculations of tip amounts beneath the
signature line on its charge receipts for food and beverages provided to customers. The
actual tip line is left blank. Customer G’s charge receipt shows sample tip calculations
of 15%, 18% and 20% of the price of food and beverages. Customer G inserts the
amount calculated at 15% on the tip line and adds this amount to the price of food and
beverages to compute the total. Under these circumstances, Customer G was free to
enter any amount on the tip line or leave it blank; thus, Customer G entered the 15%
amount free from compulsion. Customer G and Restaurant X did not negotiate the
amount nor did Restaurant X dictate the amount. Customer G generally determined
who would get the amount. The amount Customer G entered on the tip line is a tip
within the meaning of section 3121 of the Code.
Q2. What tips must be reported to the employer?
A2. All cash tips received by an employee are wages for FICA tax purposes and,
therefore, must be reported to the employer unless the cash tips received by the
employee during a single calendar month while working for the employer total less than
$20. If an employee works for more than one employer during a month and receives
less than $20 in tips while working for each employer, no tips are required to be
reported to any of the employers. Cash tips include tips received from customers,
charged tips (e.g., credit and debit card charges) distributed to the employee by his or
her employer, and tips received from other employees under any tip-sharing

5

arrangement. Thus, both directly and indirectly tipped employees must report tips
received to their employer. Non-cash tips (i.e., tips received by an employee in any
other medium than cash, such as passes, tickets, or other goods or commodities) from
customers are not wages for FICA tax purposes and are not reported to the employer.
All cash tips and non-cash tips are includable in an employee’s gross income and
subject to federal income taxes.
Q3. How are tips reported by the employee to the employer?
A3. The employee must give the employer a written statement (or statements) of
cash tips by the 10th day of the month after the month in which the tips are received.
Form 4070, Employee's Report of Tips to Employer, is available for this purpose and
may be found in Publication 1244, Employee's Daily Record of Tips and Report to
Employer. The statement may be furnished on paper or transmitted electronically. See
§ 31.6053-1(b) of the regulations.
Q4. How are FICA taxes paid on tips which are reported to the employer by the
employee?
A4. The employer withholds the employee share of FICA taxes on the reported tips
from the wages of the employee (other than tips) or from other funds made available by
the employee for this purpose. See section 3102(c) of the Code and §§ 31.3102-3 and
31.3402(k)-1(c) of the regulations. The employer pays both employer and employee
shares of FICA taxes in the same manner as the taxes on the employee's non-tip wages
and includes the reported tips on the employee’s Form W-2, Wage and Tax Statement.
The employer makes a current period adjustment on Form 941, Employer’s
QUARTERLY Federal Tax Return, to reflect any uncollected employee FICA taxes on

6

reported tips. The employer reports any uncollected employee FICA taxes on the
employee’s Form W-2, Wage and Tax Statement. The employee must report these
amounts as additional tax on the employee’s Form 1040, U.S. Individual Income Tax
Return (or other applicable return in the Form 1040 series).
EMPLOYEE
Q5. If an employee fails to report tips to his or her employer, is the employee liable
for the employee share of FICA taxes on those unreported tips?
A5. Yes. The employee is liable for the employee share of FICA taxes on the
unreported tips. The employee pays his or her share of FICA taxes by completing Form
4137, Social Security and Medicare Tax on Unreported Tip Income, and filing it with
Form 1040 (or other applicable return in the Form 1040 series) for the year in which the
tips are actually received by the employee.
Q6. Which year's social security and Medicare rates and social security contribution
and benefit base apply to compute the employee's FICA tax liability on unreported tips?
A6. The social security and Medicare rates and the social security contribution and
benefit base applicable to the calendar year in which the tips were actually received
apply to compute the employee’s FICA tax liability. Form 4137 includes the applicable
social security and Medicare rates and social security contribution and benefit base.
The employer is not liable to withhold and pay the employee share of FICA taxes on the
unreported tips.
Q7. Are employees who fail to report tips to their employers subject to a penalty?

7

A7. Yes. Under section 6652(b) of the Code, an employee who fails to report tips
required to be reported to an employer is subject to a penalty equal to 50 percent of the
employee share of FICA taxes on those tips, unless the employee can provide a
satisfactory explanation showing that the failure was due to reasonable cause and not
due to willful neglect. The explanation must be made in the form of a written statement
setting forth all the facts alleged as a reasonable cause. This statement can be
attached to the employee’s Form 1040 (See Form 4137). If the statement is submitted
in response to a notice regarding a proposed penalty assessment, the statement must
contain a declaration that it is made under the penalties of perjury.
EMPLOYER
Q8. If an employee fails to report tips to his or her employer, is the employer liable
for the employee and employer shares of FICA taxes on those unreported tips?
A8. If an employee fails to report tips to his or her employer, the employer is not
liable for the employer share of FICA taxes on the unreported tips until notice and
demand for the taxes is made to the employer by the Service. The employer is not
liable to withhold and pay the employee share of FICA taxes on the unreported tips.
Q9. How is notice and demand made under section 3121(q) of the Code?
A9. There is no specific form or procedure prescribed for a Section 3121(q) Notice
and Demand. Notice and demand is made by the Service when it advises the employer
in writing of the amount of tips received by an employee (or employees) who failed to
report or underreported tips to the employer. Although no specific form is prescribed, a
document will constitute a Section 3121(q) Notice and Demand if it (1) includes the
words "notice and demand" and "section 3121(q),” (2) states the amount of tips received

8

by the employee (or employees), and (3) states the period to which the tips relate.
However, a document including such information will not constitute a Section 3121(q)
Notice and Demand if it states that it is not a notice and demand.
Q10. How does an employer that files Form 941 report the section 3121(q) FICA tax
liability after notice and demand is made?
A10. The employer reports the amount of the section 3121(q) FICA tax liability as a
current period liability for FICA taxes on the employer's Form 941 for the calendar
quarter in which notice and demand is made. Employers should consult the Instructions
for Form 941 to determine the correct line entry on Form 941. The employer must also
include the amount of the section 3121(q) FICA tax liability on the appropriate line of the
record of federal tax liability (Part 2 of Form 941 for a monthly depositor or Schedule B
(Form 941) for a semi-weekly depositor) corresponding to the date of the Section
3121(q) Notice and Demand.
Q11. Which year's social security and Medicare rates and social security contribution
and benefit base apply to compute the employer's FICA tax liability on unreported tips?
A11. The social security and Medicare rates and the social security contribution and
benefit base applicable to the calendar year in which the tips were actually received
apply to compute the employer’s FICA tax liability. The Service will compute the
employer’s liability, and include a calculation worksheet with the Section 3121(q) Notice
and Demand.

9

Q12. If the Service determines that an employer's employees have unreported tips
and issues a Section 3121(q) Notice and Demand to the employer, what is the period of
limitations for the Service to assess the employer share of FICA taxes?
A12. Generally, the period of limitations for assessment under section 6501 of the
Code is 3 years after the due date of the return or the date the return was filed,
whichever is later. However, section 6501(b)(2) provides that employment tax returns
reporting FICA taxes for any period ending with or within a calendar year filed before
April 15 of the succeeding calendar year are deemed filed on April 15 of such
succeeding calendar year.
As a general rule, the Service must assess the employer FICA taxes on the
unreported tips within 3 years after April 15 of the calendar year following the year in
which the Section 3121(q) Notice and Demand is made. For example, if the notice and
demand is dated December 31, 2012, the liability is required to be reported on Form
941 for the fourth quarter of 2012, due on January 31, 2013. If the employer timely files
Form 941, the period of limitations for assessment ends on April 15, 2016.
However, if the employer did not file its Form 941 for the fourth quarter of 2012
before April 15 of the succeeding calendar year (April 15, 2013) and instead filed on
May 10, 2013, the Service must assess the employer FICA taxes by May 10, 2016, the
date 3 years after the date the return was filed.
If the employer files a false or fraudulent Form 941 for the quarter in which the
liability is required to be reported or fails to file Form 941 for that quarter, the Service
can assess the additional employer FICA taxes on the unreported tips at any time.

10

These assessment periods apply whether or not the employer accurately reports the
liability on Form 941 as required by Q&A 10 above.
Q13. Is the employer liable for interest on the employer’s FICA tax liability for
unreported tips?
A13. Generally, no. If the employer pays the tax on or before the due date of the
Form 941 for the quarter during which notice and demand is made, the employer is not
liable for interest. If the employer does not pay the tax by the due date of the return,
interest will accrue on the underpayment from the due date of the return.
Q14. Is the employer required to deposit FICA taxes due on the unreported tips
shown on the Section 3121(q) Notice and Demand?
A14. Yes. The employer must make deposits pursuant to section 6302 of the Code
and § 31.6302-1 of the regulations. For purposes of applying the deposit rules, the
amount of employer FICA taxes shown on the Section 3121(q) Notice and Demand, is
treated as employment taxes accumulated by the employer on the date the Section
3121(q) Notice and Demand is made, which is the date printed on the notice and
demand document. The Service generally intends to notify an employer at least 30
calendar days in advance of the issuance of a Section 3121(q) Notice and Demand.
Q15. Is the section 45B credit, with respect to the tips reported on the Section
3121(q) Notice and Demand, available to the employer in the year the notice and
demand is made or the year in which the unreported tips were received by the
employee?

11

12
A15. The section 45B credit is applied to the taxable year that the “excess social
security tax” amount is paid or incurred. The section 45B(b)(1) definition of “excess
social security tax” is limited to tips that “are deemed to have been paid by the employer
to the employee pursuant to section 3121(q).” Under this definition of “excess social
security tax,” such tax cannot be paid or incurred prior to the time that the tip amounts
are deemed to have been paid under section 3121(q), which occurs on the date on
which notice and demand for the employer share of FICA taxes is made to the
employer. Therefore, the section 45B credit is available to the employer in the year the
Section 3121(q) Notice and Demand is made and not the year in which the unreported
tips were received by the employee. The credit is claimed on Form 8846, Credit for
Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.
EFFECT ON OTHER REVENUE RULING(S)
Rev. Rul. 95-7 is modified and superseded.

DRAFTING INFORMATION
The principal author of this revenue ruling is Linda L. Conway-Hataloski of the
Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government
Entities). For further information regarding this revenue ruling, contact Linda L.
Conway-Hataloski at 202-622-0047 (not a toll-free call).