Employer FICA tax on unreported tip income.

• Author: Beck, Allen M.
• Position: Federal Insurance Contributions Act

In Fior D'Italia, Inc., 122 S. Ct. 2117 (2002), the Supreme Court reversed the Ninth Circuit, granting the IRS the authority to assess employer FICA taxes on estimated unreported tip income. Moreover, the IRS has the authority to determine these estimates based on the aggregate-estimation method. This latest development creates a new headache for employers with tip employees (primarily in the restaurant industry).

Overview

The IRS has attempted to force accurate reporting of tips, to no avail. Prior to Fior D' Italia, it implemented TRAC (Tip Reporting Alternative Commitment). Expiring in 2005, TRAC was meant ideally to lessen an employer's burden by educating employees on the importance of correctly reporting tip income. If the employer participated, the IRS would not pursue aggregate assessments based on estimates of unreported tip income. Further, under Sec. 45B an employer receives a credit for FICA taxes paid in excess of tips treated as wages for minimum-wage purposes.

Employer Tipping Options

With the IRS's new-found authority, an employer has two options in planning for a potential IRS assessment.

Option #1. The employer could do nothing and prepare a defense if the tip income reported is challenged. The potential benefit is a large savings after taking into account employee FICA and income tax, and employer FICA, FUTA, unemployment insurance and workers' compensation on each additional dollar reported, plus no penalties or interest incurred up until an assessment. However, this is a risky approach; an unsuccessful defense could mean payment of aggregate assessments of tax, penalties and interest for three years or more. Does the benefit of a tax savings today outweigh the cost of a potentially large assessment in the future?

Option #2. An employer could do everything within reason to promote accurate tip reporting. For example, it could continue to educate employees and compare tip income reported with that charged. While employers have little...