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Employees' 'Tip Income' and the IRS

By G.J. Stillson MacDonnell and William Hays Weissman

Employers that have a lot of tipped employees often face a host of employment law challenges, including payroll. Under the Internal Revenue Code ('Code'), tips are income subject to income tax withholding and usually subject to Social Security and Medicare taxes as well. Problems often arise when the employer does not know exactly how much tip income an employee receives, either because they are in cash, or because the employees, such as hosts or busers, are indirectly tipped by other employees, such as waiters.

To help employers with these issues, the Internal Revenue Service (IRS) has developed several programs designed to reduce the potential negative tax consequences of employee under-reporting or misreporting of tip income. While these programs do not alter the legal requirements regarding the taxation of tip income, they are designed to help reduce compliance burdens and opportunities for error. The IRS also announced a new program, which began on Jan. 1, 2007.

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