Internal Revenue Service
National Tip Reporting Compliance
3251 North Evergreen Dr. NE
Grand Rapids, MI 49525
Dear Sir or Madam:
The National Restaurant Association (“NRA”) respectfully submits the following comments pursuant to
Internal Revenue Service (“IRS”) Announcement 2012-25, “Interim Guidance on Rev. Rul. 2012-18.” The
announcement seeks public comments on interim guidance issued to IRS examiners on June 7, 2012, following
the issuance of Revenue Ruling 2012-18 regarding the characterization of a payment as a tip or service charge.
The NRA has been the restaurant industry's leading association since 1919 and represents more than
380,000 businesses. The restaurant industry employs 12.9 million Americans in 970,000 locations, with 2012
sales expected to reach $632 billion. Tips and service charges are customary within the industry, and clarity
and consistency in the treatment of tips and service charges for FICA tax purposes is important for employers
and employees alike. The availability of the Section 45B FICA tip tax credit to the restaurant industry makes
this issue of particular importance to NRA members.
The NRA submits these comments with the goal of working with the IRS to facilitate voluntary
compliance with the applicable tax laws pertaining to tips and service charges in a way that is understandable
and fair to the restaurant industry, without imposing undue recordkeeping burdens and costs on business
owners and employees.
Characterization of Tips vs. Service Charges
Rev. Rul. 2012-18 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 deemed a service charge:
1)
2)
3)
4)
The payment must be made free from compulsion;
The customer must have the unrestricted right to determine the amount;
The payment should not be the subject of negotiation or dictated by employer policy; and,
Generally, the customer has the right to determine who receives the payment.
These factors first appeared in IRS guidance in Rev. Rul. 59-252, 1959-2 C.B. 215. Both the IRS and the
restaurant industry have been operating under these guidelines for over fifty years, whether by establishing
recordkeeping practices and tip/service charge reporting procedures, conducting IRS examinations, or entering
into Tip Reporting Alternative Commitment (“TRAC”) or other types of tip reporting agreements.
The IRS states the purpose of Rev. Rul. 2012-18 is to “clarify” and “update” guidelines first presented in
Rev. Rul. 95-7, 1995-1 C.B. 185, which generally concerns procedural issues regarding the reporting of
employment taxes and does not address the four factors listed above. However, Rev. Rul. 2012-18 also
includes a substantive discussion of the tip vs. service charge standards, and much of the interim guidance is
focused on the procedures examiners must follow when a payment is re-characterized from a tip to a service
charge. Specifically, the guidance states that any re-characterizations must be applied retroactively, and only in
very limited circumstances will a prospective re-characterization be allowed.
NRA members have attempted in good faith to understand and comply with these IRS standards for
over five decades. They have longstanding processes and procedures in place, including those memorialized in
TRAC and other agreements with the IRS. These mechanisms reflect members’ historical technological
capabilities to track tip and service charge payments, and their experience with IRS compliance requirements
and enforcement standards. To the extent that the IRS is placing new, different or enhanced emphasis on the
four factors, perhaps in part because of advances in point of sale technology or the new credit card information
reporting requirements, businesses should not be retroactively taxed and penalized. They should reasonably
be able to expect that their past capabilities and experience will be respected by the IRS, and given adequate
time to understand, implement and comply with any changes in IRS policy or enforcement.

The IRS should not retroactively assert additional taxes, interest and penalties on restaurant owners as
a result of new or different emphasis on standards in place for over fifty years.

The IRS should provide restaurant owners a reasonable period of time, and no earlier than January 1,
2014, to make the necessary technological and procedural changes to prospectively comply with
updated IRS expectations. This could include hardware and software upgrades, changes to employee
tip reporting procedures, and educating employees regarding the characterization of tip and service
charge income.

The IRS should consider whether restaurants falling below certain gross receipts or employee
thresholds should be provided additional time to comply with updated requirements to take into
account disproportionate implementation burdens and costs.
Clarification of Standards
Clarification of the IRS standards to characterize tip vs. service charge income is necessary to resolve
questions not addressed in Rev. Rul. 2012-18 and the interim guidance. These questions include the following:
1) Rev. Rul. 2012-18 states that the absence of any of the four factors creates a doubt as to whether a
payment is a tip. If a payment meets only three of the four standards, should it be treated as a service
charge? Are the four factors equally weighted? For example, in some circumstances, a customer may
freely decide whether to leave a payment and the amount of the payment independent of restaurant
policy, yet may not control whether the waiter is required to share the tip with other staff, i.e., “tip out.”

The IRS should clarify how employers must evaluate the factors for purposes of determining the
character of a payment. The IRS should take ambiguous circumstances and gray areas into account
when determining whether to propose adjustments and penalties.
2) The guidance does not address how to characterize a payment in excess of a stated service charge,
e.g., if the service charge is 18% of the bill and a customer leaves a payment in the amount of 25% of
the bill, should the additional 7% be characterized as a tip or a service charge?

The IRS should clarify the treatment of payments in such situations, and allow reasonable and readily
administrable procedures to minimize burden on businesses and facilitate compliance.
3) The interim guidance states that changes to the characterization of a payment should be applied
retroactively, except in the case of very limited facts and circumstances. The guidance states that
examiners should consider whether the facts and circumstances were addressed in prior guidance and
whether the business needs additional time to amend its business practices and make system changes
when considering prospective treatment. Is this test a conjunctive test,( i.e., must there be a lack of
guidance and the need to make practice and system changes), or is this a disjunctive test,( i.e., only one of
these circumstances must exist)?

The IRS should apply Rev. Rul. 2012-18 and the interim guidance prospectively in all cases. Each of
these circumstances should be considered independently for purposes of determining additional taxes
and penalties in the future.
Renegotiating TRAC and Other Agreements
The interim guidance provides that businesses may be contacted by the IRS to renegotiate existing
TRAC and other agreements, and that such contacts will not be considered a tip examination. To avoid
confusion, uncertainty and unnecessary administrative burdens and costs on businesses, the IRS should not
pursue changes to existing agreements without industry input and until additional guidance is issued
concerning the characterization of tip and service charge income.
The NRA appreciates the opportunity to provide these comments. We look forward to working in
partnership with the IRS to develop policies and procedures that will facilitate voluntary tax compliance in the
area of tip reporting in a fair and cost effective manner. To facilitate working with the IRS in this area, it is
critical for the National Restaurant Association and other stakeholders who participated in the 2011 MITRE Tip
Reporting Study prepared for the IRS to promptly receive a copy of the Report or at the very least a
comprehensive summary of its findings. This is an important step in furthering the discussion between the IRS
and the restaurant industry in achieving our common goal of enhanced voluntary Tip Reporting.
Sincerely,
David G. Koenig
Vice President, Tax & Profitability