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New IRS Audit Program for Unreported Tips

The IRS is beginning a new program using data from employees' Forms 4137, Social Security and Medicare Tax on Unreported Tip Income to determine the employer's share of social security and Medicare taxes on unreported tips.

Employers in industries where tipping is common know that they must pay the employer's share of social security and Medicare taxes on tips employees report to them. However, many employers do not realize that they may be liable for these taxes on tips employees do not report to them.

For tips which the employees did not report to the employer, the employer's liability for the employer's share does not arise until IRS issues a Section 3121(q) Notice and Demand. In the past, the IRS has issued notice and demands based on tip audits using estimates, including data from Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips.

Under this new initiative, a Section 3121(q) Notice and Demand will be based on information the IRS collects from employees' Forms 4137. Employees use Form 4137 to report and pay their share of social security and Medicare taxes due on the tips they did not report to their employer. This includes any tips allocated to employees of large food and beverage establishments. Generally, employees must include the allocated tips as income on their income tax returns unless they have adequate records to show that they received less tips in the year than the allocated figures.

The IRS generally intends to notify an employer at least 30 calendar days in advance of the issuance of a Section 3121(q) Notice and Demand by issuing a pre-notice. The IRS has a designated staff to help resolve any discrepancies the employer notes on the pre-notice.

A Section 3121(q) Notice and Demand instructs the employer to include the social security and Medicare taxes shown on the notice and demand on the employer's next Form 941, Employers QUARTERLY Federal Tax Return. The employer will not be subject to any interest charges or deposit penalties if the employer properly reports the taxes as instructed in the notice and demand and remits the tax due with its Form 941, or if a deposit is required makes that deposit timely.

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