IRS Tip Agreements | Government & Legal | National Restaurant Association

IRS Tip Agreements

The National Restaurant Association's Tip Reporting Education Kit has tools to help everyone in the restaurant — from managers to servers — understand tip reporting.

The IRS wants you to sign a tip agreement. What do you do?
Last updated February 2002

Update: On July 31, 2006, the IRS announced it would be offering another tip agreement, called ATIP. Get an ATIP update here.

Frustrated by what it claims is widespread underreporting of tip income, the Internal Revenue Service (IRS) has been trying since the mid-1990s to get restaurant employers to take on a much bigger role in employee tip reporting.

The agency has been asking restaurateurs to sign a contract called the Tip Reporting Alternative Commitment (TRAC). Under the TRAC, a restaurant agrees to assume greater responsibility for getting employees to report their tips. In return, the IRS agrees that it will not bill the restaurant for FICA taxes on allegedly unreported tips unless it has first examined employees.

If you've been approached by the IRS about signing a TRAC -- or about coming up with your own version of a TRAC, called an EmTRAC -- here's some background to help you figure out what's going on.

Note: The following information is provided by the National Restaurant Association as a member service and is not intended as legal, tax or other professional advice or counsel. The National Restaurant Association strongly encourages readers to consult with their attorneys or accountants prior to taking any action based on the information contained here.

What is the TRAC?
Why would a restaurateur sign a TRAC agreement?
What are an employer's obligations under the TRAC?
The EmTRAC: An alternative to the TRAC
To sign or not to sign
Frequently-asked questions

What is the TRAC?

The TRAC is an agreement a restaurateur signs with the IRS under which the restaurateur agrees to (1) regularly educate employees about tip reporting and (2) set up certain procedures to make sure servers, buspersons and others report their credit-card and cash tips to their employer. See Tip-Reporting Tools & Resources for links to the TRAC agreement on the IRS's Web site.

Why would a restaurateur sign a TRAC agreement?

There's one reason: If you sign and comply with the TRAC, the IRS will not assess you for FICA -- Social Security and Medicare -- taxes on unreported tips unless the IRS has first examined your employees. If you don't sign, the IRS maintains it has the right to look at your records and then bill you for FICA taxes on tips the agency says employees failed to report –- without ever looking at individual employees' records. (Many restaurants have challenged the IRS's "employer-only" audit tactics; read more for the status of these cases.)

Important note: Signing and complying with the TRAC does not guarantee that you won't be audited. The agreement only guarantees that if the IRS does audit you and issue an assessment for FICA taxes on unreported tips, the assessment will be based on the IRS's examination of an employee.

What are an employer's obligations under the TRAC?

Basically, any employer who signs a TRAC agreement with the IRS agrees to do the following:

1. Educate employees about tip reporting
If you sign a TRAC agreement with the IRS, you agree to train your newly-hired employees about proper tip reporting and to "re-educate" all tipped employees at least once a quarter. Your training must emphasize three points:

Employees are obligated to report 100% of both cash tips and charge-card tips.

Employees must keep records to document their daily earnings, and

Proper tip reporting has benefits, like higher Social Security benefits later in life.
What counts as training? The IRS says you can use brochures, videos, posters, or other materials to teach employees about tip reporting. The National Restaurant Association offers a Tip Reporting Education Kit with posters, payroll-stuffers, brochures and other tools you can use to get the word out to employees. The IRS also offers some training material, or you can come up with your own.

2. Establish tip-reporting procedures.
Current law already requires any employee who earns $20 or more in tips in a month to report those tips to their employer by the 10th day of the following month. Employers who sign a TRAC agreement take on extra responsibilities:

For directly-tipped employees (i.e., those who receive tips directly from customers): Employers enrolled in the TRAC must come up with a procedure where a written statement is prepared at least once a month showing all charge-card tips for the sales attributable to each directly-tipped employee. Statements may be prepared more often than every month, such as at the end of every shift. There must be a procedure in place for directly-tipped employees to (1) verify or correct this charged-tip total to reflect tip-outs, tip pools, etc., and (2) sign the written statement. The employer must also establish a procedure to get written reports of directly-tipped employees' cash tips. The statement must be signed by the employee and turned in to the employer at least once a month. (The same statement may be used for reporting charge-card and cash tips.)

For indirectly-tipped employees: Employers who sign the TRAC must develop a procedure for indirectly-tipped employees to report the tips they receive. This applies to buspersons, service bartenders or others whose tips come from other employees rather than directly from customers.

3. Keep up with all tax payment and filing obligations.

File and pay on time: Employers who sign a TRAC agreement must keep up with all their tax payment and filing obligations. This means filing IRS Form 941, Employer's Quarterly Federal Tax Return; Forms W-2, Wage and Tax Statements; and, for larger employers, Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips. (If you are participating in the TRAC you need to file your 8027 form not just with the IRS's national office, but also with your local IRS office.)

Keep records: All restaurants that sign a TRAC agreement must keep records showing gross sales subject to tips and charge receipts with charged tips. Records for a calendar year must be retained for at least four years after the following April 15.

Produce documents on request: At the IRS's request, restaurants enrolled in the TRAC must produce quarterly totals showing total gross receipts subject to tipping; total charge receipts with charge-card tips; total charge-card tips reported; and total reported tips.

The EmTRAC: An Alternative to the TRAC

The National Restaurant Association has worked with the IRS on an alternative to the TRAC. This program allows a restaurant to design its own TRAC, known as an EmTRAC (Employer's Tip Reporting Alternative Commitment), as a substitute for the regular TRAC.

Employers who work with the IRS to develop a customized "EmTRAC" agreement get the same protections the TRAC provides -- i.e., protection from employer-first audits. The advantage of the EmTRAC is that it gives employers a little more flexibility to develop tip-reporting procedures that better suit their needs. And while an EmTRAC must be approved by the IRS, it doesn't require an employer to enter into a formal written contract with the IRS.

Basically, employers who opt to enter into an EmTRAC agreement:

develop and submit for IRS approval a tip education and reporting program for employees

comply with tax reporting, filing and payment requirements, just as under the TRAC

maintain certain employment records, just as under the TRAC.

For more information about the EmTRAC see Tip Reporting Tools & Resources for links to the IRS's Web site or contact Kathleen O'Leary at the National Restaurant Association at koleary@dineout.org .

To Sign or Not to Sign

If you're approached by the IRS about signing a TRAC agreement, here are a few things to consider:

If you don't sign a TRAC, the biggest fear is that you could be audited and billed for FICA taxes on tips employees allegedly failed to report. Your employees may also be audited, which means both they and you could be billed for taxes on unreported tips. (Note: If you are billed for FICA taxes on unreported tips, be aware that you may be eligible for a tax credit to offset this tax bill.)

If you do sign a TRAC, you'll be doing more paperwork; you'll be doing more policing of employees' tip reports; and you'll be turning over quarterly data on tips to the IRS if the agency requests it.

What does the NRA recommend?
In May 2000, after several court rulings unfavorable to the restaurant industry and after the IRS announced it intended to step up its rate of employer-only audits and assessments on unreported tips, the National Restaurant Association adopted a position strongly urging restaurateurs to implement an approved tip reporting program –- whether a TRAC or an EmTRAC -- as the most reliable course of action for avoiding potentially damaging audits and assessments by the IRS for allegedly underreported tips.

Frequently Asked Questions

What is an employer-only audit?
It's a current practice used by the IRS to determine if employees are underreporting tips. The IRS will review employer tip-reporting data and if the reported credit-card tips vary greatly from the reported cash tips, or if the overall tip-reporting percentage is low, the IRS will use a formula to assess the employer for taxes owed on the allegedly unreported amount, without determining which employees underreported their tips.

Is my restaurant safe from an audit if my employees report tips equal to 8% of their sales?
No. This is a dangerous misperception in the restaurant industry. Employees are required to report and pay taxes on 100% of the tips they keep after tip-outs. Reporting less than 100% can get both employers and employees in trouble. Review the tip-reporting basics for more information.

If courts rule that the IRS's employer-only audit tactics are illegal, why would I need to sign a TRAC agreement?
Regardless of the way the courts rule -- including the U.S. Supreme Court, which could rule on this issue by summer 2002 (see legal update) -- the debate is most likely to move to Congress for a final resolution. At issue is whether Congress intended to give the IRS the authority to conduct "employer-only" audits and assessments. At this point, restaurateurs should not base their decision about whether or not to sign a tip-reporting agreement on the U.S. Supreme Court's ruling. It's likely there's still a long way to go before the issue gets resolved.

Can I terminate a TRAC agreement?
Yes, with sufficient notice given to the IRS in writing.

My company operates in a number of IRS districts. Does each of my units need to sign a separate TRAC agreement?
No. If a multi-state restaurant wants to participate in a TRAC or EmTRAC agreement, the IRS says it's OK for the company to run all its TRAC- or EmTRAC-related paperwork through a single IRS office (the one where the company is headquartered), rather than deal separately with each IRS office where the company has a store.

How long do I have to establish procedures if I sign a TRAC agreement? When will the IRS review the results of the program?
Realizing it will take a restaurateur time to implement the TRAC, the IRS gives restaurateurs six months from the time the TRAC takes effect to get their employee education programs, tip-reporting procedures and recordkeeping systems in place. The IRS may review an employer's progress during this time but can't officially evaluate an employer's compliance until the end of these six months.

Can the IRS terminate the agreement?
The only reason the IRS can terminate an agreement is if it finds the establishment is not complying with the TRAC's requirements. Check the language of the TRAC for more details.

What if I notice a discrepancy between employee reports and register reports?
As long as you have established the procedures that the TRAC requires -- preparing a written statement showing all the charge-card tips attributable to each server; requiring the server to verify or correct this amount and sign off on it; and requiring the server to provide a written statement of cash tips -- you have fulfilled your obligations under the TRAC.

If you make a good-faith effort to follow the guidelines but your employees still fail to report tips, the IRS says it will not hold you responsible. In October 1999 the agency's national office affirmed that in these cases it will focus on the employees who are not in compliance with tip reporting, rather than pursuing the employers.

What results is the IRS looking for?
National IRS officials say they are looking for more accurate reporting of both charge-card tips and cash tips. They are also looking for tip reports from all employees, including indirectly-tipped employees.

I feel uncomfortable policing my employees' tip reports. Does the TRAC require that?
The TRAC does not require the employer to monitor or verify the tips employees report. The TRAC only requires employers to make a good-faith effort to follow all the guidelines of the agreement. However, it's in an employer's interest to convey the "100% tip reporting" message loud and clear, since underreporting puts both employers and employees at risk of an audit.

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