How to get tip reporting on TRAC.

• Author: Werblow, Jordan M.
• Position: Tip Reporting Alternative Commitment agreements

In June 1995, the IRS developed the Tip Reporting Alternative Commitment Agreement (TRAC agreement) in an effort to improve employee tip reporting in the food and beverage industry. In short, the TRAC agreement obligates a restaurateur to educate employees about tip reporting responsibilities. The restaurant must develop a procedure for tracking the reporting of charge-card tips by both directly and indirectly tipped employees; it also agrees to establish a procedure to ensure that cash tips are reported by all employees. In return, the restaurant is given assurance by the Service that it will not be subject to a FICA tax audit on unreported employee tips during the period the TRAC agreement is in effect. The TRAC agreement does not, however, encompass the determination of a tip rate based on historical data and the "McQuarters Formula" as is found in the existing Tip Rate Determination Agreement. The decision to enter into a TRAC agreement is voluntarily made by an employer.

In the early 1990s Congress amended Sec. 3121(q), making employers liable for FICA taxes on reported as well as unreported employee tips retroactive to 1988. The IRS looked at the amended Sec. 3121(q) as a way to increase tip reporting by going directly to employers with the threat of a tip audit.

The execution of the TRAC agreement grants an employer a degree of audit protection. The Service promises that employers who sign and comply with the agreement will not be subject to "employer only" or "employer first" audits for FICA taxes on unreported tips both retroactively to 1988 and prospectively. Therefore, the IRS will issue a notice for employer FICA taxes on unreported tips only in two cases: (1) when the employee is audited and it is determined that the employee did not accurately report tips; and/or (2) when the employee files Form 4137, Social Security and Medicare Tax on Unreported Tip Income, in order to voluntarily declare and pay FICA taxes on previously unreported tips.

To apply for the TRAC, employers must submit a signed application in writing to their local IRS district director. Restaurants operating numerous establishments can cover any number of the establishments by filing one application in the IRS district where the company is headquartered. A standardized copy of the TRAC agreement can be found in the IRS Market Segment Understanding issued June 1, 1995.

The TRAC agreement is structured in a way that provided an incentive to sign up for the...