TREASURY INSPECTOR GENERAL FOR TAX
ADMINISTRATION
Additional Enhancements
Could Improve Tax Compliance of Employees Who Receive Tips
September 15, 2006
Reference Number: 2006-30-132
This
report has cleared the Treasury Inspector General for Tax Administration
disclosure review process and information determined to be restricted from
public release has been redacted from this document.
Phone Number |
202-927-7037
Email Address | Bonnie.Heald@tigta.treas.gov
Web Site |
http://www.tigta.gov
September 15, 2006
MEMORANDUM FOR COMMISSIONER, SMALL BUSINESS/SELF-EMPLOYED DIVISION
FROM: Michael R. Phillips /s/ Michael R. Phillips
Deputy Inspector General for Audit
SUBJECT: Final Audit Report – Additional Enhancements Could Improve Tax Compliance of Employees Who Receive Tips (Audit # 200530029)
This report presents the results of our review of the Internal Revenue Service’s (IRS) Tip Rate
Determination and Education Program (the Tip Program). The overall objective of this review was to
determine the progress the IRS has made in improving the Tip Program and
expanding it to other industries where tipping is customary. Specifically, we reviewed the actions taken
by the IRS based on the recommendations from a previous Treasury Inspector
General for Tax Administration report.[1]
Impact on the Taxpayer
Although the IRS has made some enhancements to the Tip Program since our prior review, additional improvements could help achieve a higher level of tip income reporting compliance. We estimate the IRS could achieve $342 million in additional tax assessments over 5 years if it resumes soliciting new tip agreements with the Cosmetology industry and expands the agreements to the Taxi/Limo industry.
Synopsis
The reported amount of tip income increased from $8.52 billion for Tax Year (TY) 1994 to over $19 billion for TY 2004. However, the IRS has not consistently monitored the establishments in the Food and Beverage and Cosmetology industries that had entered into tip agreements since Fiscal Year (FY) 2000 to determine if tip agreements secured actually increased tip income for these establishments.
Due to the voluntary nature of participation and limited staffing resources, disparity over the number of tip agreements secured in various locations across the country has continued to be an issue since our prior report. The IRS does not plan to actively solicit any new tip agreements beyond the Gaming industry in FY 2006. The majority of FY 2006 Tip Program staffing will be expended on soliciting and monitoring tip agreements with the Gaming industry and on audits of casino employees. Additionally, multiple realignments affected the transition of the outreach portion of the Tip Program from the Compliance function to the Taxpayer Education and Communication function. The Tip Program has not expanded to the Taxi/Limo industry.
The IRS has not yet established an automated system to identify business entities required to file an Employer’s Annual Information Return of Tip Income and Allocated Tips (Form 8027).[2] The IRS recently manually matched the Employer’s Quarterly Federal Tax Return (Form 941) data to the database of TY 2004 Forms 8027, identifying 33,685 employers as potential Form 8027 non-filers. However, the Form 8027 database data fields are not always accurate, and only the first quarter of TY 2004 Forms 941 have been matched to this database. Identification of Form 941 non-filing was not prioritized.
The IRS has automated the tracking of tip agreements for the
Food and Beverage and Cosmetology industries.
This automated database is part of a system that is not fully operational but is now funded with
a tentative date of FY 2008 for full implementation. However, the Gaming industry tip agreements
are maintained in a separate database that does not accommodate all
necessary information, preventing consistent use of the information.
The Tip Program does not reach some small businesses in the
Food and Beverage industry. To address
this, the IRS developed the Attributed Tip Income Program Revenue Procedure,
which the Department of the Treasury approved on July 11, 2006. The IRS plans to test it for 3 years. A similar Revenue Procedure is needed for
small businesses in other industries.
Recommendations
We recommended the Director,
Specialty Programs, ensure adequate staffing remains available for monitoring
tip agreements for all industries and use the results of monitoring to measure compliance;
prepare a workforce plan to determine the necessary staffing levels needed to
accomplish Tip Program goals; ensure the automated tracking system remains funded and, once fully
operational, includes the Gaming industry tip agreements; implement data
verification procedures for Form 8027 data and prioritize identifying Form 941
non-filers; once the Attributed Tip Income Program Revenue Procedure
is tested with the Food and Beverage industry for 1 year, consider developing a
similar Revenue Procedure for small businesses in other industries; and
establish an action plan to outline and monitor all planned actions, potential
results, responsible individuals, staff to be allocated, and planned completion
dates.
Response
IRS management agreed with all of our recommendations. The Director, Specialty Programs, will ensure consistent review and monitoring of existing and future voluntary agreements is done for all industries. The data from monitoring will be used to measure compliance. A Tip Program strategy will be developed to ensure the Program has sufficient staffing and resources to further tip compliance. Procedures will be developed to enhance current data verification procedures regarding Forms 8027. Potential Form 941 non-filers will be identified along with potential Form 8027 non-filers. IRS management will ensure development of the automated tracking system meets its estimated completion date of October 2008. The system will include the Gaming industry tip agreements. The Attributed Tip Income Program Revenue Procedure was issued on July 28, 2006, for small food and beverage establishments. When sufficient data have been captured after a 3-year pilot, they will be analyzed to determine if a similar Revenue Procedure for other industries would be beneficial. An action plan to monitor progress will be developed and will be consistent with information included in the Tip Program strategy.
IRS management did not agree with our estimate of additional tax assessments because they were unable to validate our estimate and the assumption that each taxpayer contact will result in full compliance. Management’s complete response to the draft report is included as Appendix V.
Office of Audit Comment
We believe our estimate of potential additional tax assessments is valid. Our calculation was based on the FY 2005 methodology the IRS uses for selecting Cosmetology industry businesses for tip agreement leads and the actual results for tip examinations.
In addition, although the IRS’ suggested evaluation period for the Attributed Tip Income Program Revenue Procedure is longer than we envisioned in our recommendation, we agree it is not unreasonable to expect such data capture and analysis to take up to 3 years.
Copies of this report are also being sent to IRS managers affected by the report recommendations. Please contact me at (202) 622-6510 if you have questions or Daniel R. Devlin, Assistant Inspector General for Audit (Small Business and Corporate Programs), at (202) 622-8500.
Some Progress Has Been
Made to Enhance the Tip Program
Additional Methods
Could Be Used to Measure the Effectiveness of the Tip Program
A Workforce Plan Is
Needed to Ensure Staffing Levels Are Adequate to Achieve Tip Program Goals
The Processing of
Tip Program Data Needs Additional Improvement
A Method to Increase
Tip Reporting for All Small Businesses Is Needed
An Action Plan Is
Needed to Ensure Adequate Monitoring of Future Progress
Appendices
Appendix
I – Detailed Objective, Scope, and Methodology
Appendix
II – Major Contributors to This Report
Appendix
III – Report Distribution List
Appendix V
– Management’s Response to the Draft Report
Abbreviations
|
ATIP |
Attributed Tip Income Program |
|
EmTRAC |
Employer-designed Tip Reporting Alternative Commitment |
|
FY |
Fiscal Year |
|
GITCA |
Gaming Industry Tip Compliance Agreement |
|
IRS |
Internal Revenue Service |
|
SB/SE |
Small Business/Self-Employed |
|
SWETRS |
Service Wide Employment Tax Research System |
|
TEC |
Taxpayer Education and Communication |
|
TIGTA |
Treasury Inspector General for Tax Administration |
|
TRAC |
Tip Reporting Alternative Commitment |
|
TRDA |
Tip Rate Determination Agreement |
|
TY |
Tax Year |
|
U.S. |
United States |
Historically, the Internal Revenue Service (IRS) has been concerned with employees not reporting tips earned in industries in which tipping is customary. An IRS study showed that the amount of tip income reported in Calendar Year 1993 was less than one-half of the tip income amount, leaving over $9 billion of unreported income.
As a result, the IRS developed the Tip Rate Determination and Education Program (the Tip Program), which is a voluntary compliance program originally developed in 1993 for the Food and Beverage industry. It was modeled after the tip compliance agreement used by casinos in the former IRS Nevada District. The Tip Program was extended to the Cosmetology industry in 1997 and the Barber industry in 2000. Since the Tip Program was introduced, voluntary compliance has increased significantly. In Tax Year (TY) 1994, tip wages reported were $8.52 billion. For TY 2004, the amount exceeded $19 billion. To date, over 16,000 employers, representing over 47,000 individual establishments, have entered into tip agreements.
The Tip Program offers employers
multiple voluntary agreement options designed to provide nonburdensome methods
for employers and employees to comply with tip reporting laws. Options include:
· A Tip Reporting Alternative Commitment (TRAC) – Under a TRAC, the employer agrees to institute and maintain a quarterly educational training program that trains newly hired employees and periodically updates existing employees as to their reporting obligations with respect to tips.
· An Employer-designed Tip Reporting Alternative Commitment (EmTRAC) – This program was initiated in December 2000 and allows any food or beverage establishment the opportunity to develop its own tip compliance program. An EmTRAC maintains the same filing, reporting, and educational requirements as an IRS-administered TRAC. Employers must apply in writing to obtain IRS approval of their programs and receive the same benefits and protections afforded under a TRAC. Very few EmTRACs have been submitted and approved.
· A Gaming Industry Tip Compliance Agreement (GITCA) – A GITCA is specifically designed for employers in the Gaming industry to determine tip rates for various occupations in the establishment by using historical tip data. These rates are subject to review and validation by the IRS. At least 50 percent of the tipped employees in the establishment must participate by signing a Model Gaming Employee Tip Reporting Agreement.
Participation in a tip agreement provides benefits for both employees and employers. Assuming that the employer recognizes higher income, employees would be eligible for greater Social Security income and increased unemployment benefits and worker’s compensation. The increased income would also improve opportunities for approval when employees apply for loans. If the employer has a retirement contribution plan, there may be additional funding for employees. Once an employee signs a TRDA participation agreement, the employee will not be audited on future tips above the agreed tip rate during the agreement period. If an employee does not sign a participation agreement with an employer that has a TRDA, the employee will be subject to a possible audit. Under a TRAC agreement, tip examinations may occur for only those employees who underreport their tip income.
An employer that signs a TRDA or TRAC agreement will be deemed to be in compliance, meaning the IRS will not audit the employer’s payroll tax returns for periods prior to the agreement or for those years covered by the agreement, as long as the employer remains in compliance with the agreement. Both programs prohibit “employer-only assessments” (assessments without auditing the employee(s)) during the period the agreement is in effect. Thus, participating in these agreements reduces uncertainty for employers.
In May 2001, we issued a report on the Tip Program.[3] Results showed that, while the amount of tip
income reported to the IRS had consistently increased, additional enhancements
could be made to increase compliance. We
recommended the IRS reemphasize the Tip Program’s importance, provide adequate
oversight, ensure proper transfer of the Tip Program from the Employment Tax
Compliance function to the new Taxpayer Education and Communication (TEC) function,
and expand the Tip Program to other industries in which tipping is customary.
This review was performed at the Small Business/Self-Employed (SB/SE) Division Stakeholder Liaison Headquarters office and Specialty Programs office in New Carrollton, Maryland, during the period October 2005 through May 2006. The audit was conducted in accordance with Government Auditing Standards. Detailed information on our audit objective, scope, and methodology is presented in Appendix I. Major contributors to the report are listed in Appendix II.
The IRS has enhanced the Tip Program since our prior review. As of March 2006, the IRS had successfully secured 14,657
tip agreements for 41,606 establishments in the Food and Beverage industry and
1,686 tip agreements for 6,206 establishments in the Cosmetology industry. The IRS has also been successful in negotiating and securing
tip agreements from 213 casinos in 17 States coast to coast. As of December 2005, 90 Gaming industry tip
agreements had been secured, and an additional 63 agreements were in the
process of being secured.
The IRS automated the tracking of tip agreements for the Food
and Beverage and Cosmetology industries by creating the TRAC/TRDA Inventory
Delivery System database, which is part of a larger program entitled the Service
Wide Employment Tax Research System (SWETRS). The
SWETRS is a web-based system that, when fully operational, will allow cross-matching
of internal IRS program databases, identifying noncompliant employment
taxpayers for potential audits. It is
currently funded for completion in Fiscal Year (FY) 2008. Gaming industry tip agreements are maintained
in a separate database that is also being upgraded.
In January 2006, the IRS established a Centralized Data Unit
with three management and program assistants responsible for monitoring the tip
agreements. Effective October 1, 2006, the
SB/SE Division Employment Tax function is establishing an Employment Tax
Monitoring and Support Unit at the Cincinnati Campus.[4] The three Centralized Data Unit employees
will transition to this new Unit, along with two additional employees. Their responsibilities will include all
monitoring duties related to Employment Tax Programs and will not be exclusive
to monitoring tip agreements. New
training material is being developed.
Both Program placement and standardized training material will enhance
consistency in monitoring practices.
Beginning in FY 2006, the IRS created a direct line-reporting authority from the Headquarters Employment Tax Division over the Tip Program’s operations and policy, which management believes has created a greater consistency in the application of the Tip Program’s expectations and guidelines. During FYs 2004 and 2005, the IRS trained over 200 managers, tax compliance officers, tax examiners, revenue agents, and employment tax specialists from the Employment Tax Program on the Audit Technique Guide for tip rate determinations. Over 100 Stakeholder Liaison Headquarters office tip tax specialists and managers received training on conducting Tip Program outreach and education and securing TRAC agreements. Compliance personnel are responsible for the enforcement aspects of the Tip Program and for conducting examinations of employer and employee tax returns to ensure tip reporting requirements are met.
The IRS has made information regarding the Gaming, Cosmetology, and Food and Beverage industries available for the general public through its web site (IRS.gov). The web site includes information on the various types of tip agreements and publications on reporting and tracking tip income for both the employer and employee.
All of these enhancements have improved the Tip Program. However, additional improvements could help the IRS reach a higher level of tip income reporting compliance.
Additional Methods Could Be Used to Measure the Effectiveness of the Tip Program
The SB/SE Division continues to gauge the success of the Tip Program using the total Social Security Tip Wages reported on the Employer’s Quarterly Federal Tax Returns (Form 941) for all industries. As shown in Figure 1, the reported amount of tip income increased from $8.52 billion for TY 1994 to $19.15 billion for TY 2004.
Figure 1 was removed due to its size. To see Figure 1, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.[5]
The IRS has acknowledged that there are limitations to measuring tip income reported by industry because many tax returns have incorrect or missing industry codes. It specifically tracks tip income from large food and beverage establishments using information from the Employer’s Annual Information Return of Tip Income and Allocated Tips (Form 8027).[6] As shown in Figure 2, the total amount reported on Forms 8027 increased from $3.94 billion for TY 1993 to $9.18 billion for TY 2003, the latest year for which data were available.
Figure 2 was removed due to its size. To see Figure 2, please go to the Adobe PDF
version of the report on the TIGTA Public Web Page.[7]
These
increases seem to indicate the Tip Program is effective but cannot alone be
considered adequate for measuring the Program’s success. A contributing factor could be that restaurant-industry
employment has increased from 10 million in 1996 to 12.5 million in 2006. Also, tip income for the Food and Beverage
industry may be increasing because more two-income households with families are
opting for the convenience of dining out. In addition, the professional beauty services
market in the United States (U.S.) is a $62-billion industry that is
continually growing and could also contribute to the gradual increase in tip
income reported.
Due to lack of staff availability, the IRS has not consistently monitored those establishments in the Food and Beverage and Cosmetology industries that have entered into tip agreements since FY 2000 to determine if tip agreements secured actually increased tip income for these establishments. Although the IRS will have five employees available to conduct monitoring of these tip agreements, their responsibilities are not exclusive to Tip Program monitoring. Such monitoring of the agreements would provide additional assurance that IRS efforts are resulting in increased compliance levels.
Recommendation
Recommendation 1: To measure the success of the Tip Program in improving tip income reporting compliance, the Director, Specialty Programs, should ensure adequate staffing remains available to monitor the tip agreements for all industries and use the results of monitoring to measure compliance.
Management’s Response: IRS management agreed with this recommendation. The Director, Specialty Programs, will ensure consistent review and monitoring of existing and future voluntary agreements is done for all industries, as a component of the overall Tip Program strategy. The goal is to have a dedicated staff of five employees assigned to monitor compliance with the various tip agreements. The data yielded from monitoring will be used to measure compliance.
A Workforce Plan Is Needed to Ensure Staffing Levels Are Adequate to Achieve Tip Program Goals
Due to the voluntary nature of participation and limited staffing resources, disparity over the number of tip agreements secured in various locations across the country has continued to be an issue since issuance of our prior report in May 2001. As of March 2006, the TRAC/TRDA database showed the number of tip agreements per State ranged from 0 to over 1,400 for the Food and Beverage industry. In FY 2006, the IRS does not plan to actively solicit any new tip agreements except in the Gaming industry. Outreach has been limited to conducting broad-based efforts, including speeches and seminars, and workshops. However, if contacted by a business, the IRS will work with the taxpayer to secure an agreement.
Tipping noncompliance in the Cosmetology and Taxi/Limo industries is not being addressed
Based on a November 2004 research project, which recommended the IRS not spend a disproportionate amount of resources on the Cosmetology industry, the IRS discontinued soliciting and working leads for that industry. The IRS research concluded Cosmetology industry filers make up a very small portion of the total business filers (0.6 percent) and primarily have low-dollar gross receipts. Also, the IRS never expanded the Tip Program to the Taxi/Limo industry.
According to the U.S. Bureau of Labor Statistics, overall employment of barbers, cosmetologists, and other personal appearance workers is projected to grow about as fast as the average for all occupations through 2012. In addition, Figure 3 indicates a survey conducted by the U.S. Bureau of Labor Statistics in May 2004 showed careers in this field are paid higher annual salaries than those in the Food and Beverage and Gaming industries.
|
Occupations in Which Tipping Is Customary |
Total Estimated Employment |
Mean Hourly Wage |
Mean
Annual Wage |
Total Estimated Annual Income for Estimated Total
Employment |
|
Barbers |
15,830 |
$12.04 |
$25,040 |
$396,383,200 |
|
Hairdressers, Hairstylists, and Cosmetologists |
331,260 |
$10.95 |
$22,770 |
$7,542,790,200 |
|
Manicurists and Pedicurists |
38,030 |
$9.65 |
$20,080 |
$763,642,400 |
|
Concierges |
17,310 |
$11.93 |
$24,820 |
$429,634,200 |
|
Baggage Porters and Bellhops |
55,910 |
$10.46 |
$21,760 |
$1,216,601,600 |
|
Taxi Drivers and Chauffeurs |
132,650 |
$10.34 |
$21,510 |