It’s tax season, and the IRS has a new $80 billion slush fund at its disposal, thanks to the misnamed Inflation Reduction Act, which was signed into law in August.
The White House and Treasury officials told us this infusion of cash was necessary to enable the IRS to go after rich tax evaders and corporations.
It may come as a surprise, then, that the IRS is proposing to direct new scrutiny at underreported tips by waitresses, barbers, and bartenders.
Tipped employees are currently required to pay both federal income taxes and payroll taxes on the tips they receive. Workers report tips to their employers, who pay the 15.3% payroll tax to the IRS on the employee’s behalf and adjust employee wage withholding to account for the taxes workers owe on tips.
To ensure compliance, many employers participate in tip-reporting programs with the IRS.
But now the IRS is attempting to replace existing programs with a more far-reaching and invasive program that would, for example, require employers to use point-of-sale systems to record all sales subject to tipping. Employers in the program would then be required to use these electronically recorded transactions to create detailed annual employee tipping reports for the IRS.
To stay compliant with the program, employers would be required to report tips exceeding a minimum threshold that includes all electronic tips charged, plus an estimate of tips paid in cash, calculated based on the amount of sales that were subject to cash tips.
The issue here isn’t the fairness or unfairness of the IRS cracking down on underreported tips. As the feds keep blowing out the spending, everyone must bear the burden of the taxes they legally owe.
The reason the new scrutiny on tips is troubling is because it shows that the IRS secured $80 billion of new funding under false—or at least misleading—pretenses.
Proponents repeatedly told us that the massive boost in IRS enforcement funding was meant to crack down on rich taxpayers and corporations. Small businesses and Americans making less than $400,000 were led to believe they had nothing to worry about, as the new funding wouldn’t be used against them.
The White House claimed the IRS funding would “crack down on wealthy people and large corporations that cheat on their taxes.”
Recently retired IRS Commissioner Charles Rettig said, “The bottom line is this: These resources are absolutely not about increasing audit scrutiny on small businesses or middle-income Americans.”
Treasury Secretary Janet Yellen even claimed that households making under $400,000 “will actually see a lower likelihood of audit.”
And yet, here we are talking about waiters’ and waitresses’ tips.
The IRS’ increased scrutiny on tipped workers isn’t a mistake. It’s an attempt to shore up what the agency sees as a significant weakness in its enforcement. The IRS has estimated that 10% of the underreported individual income-tax gap is from tips, even though tipping income accounts for a fraction of a percent of U.S. income.
Tipped employees aren’t the only non-millionaires that the IRS has in its sights.
IRS reports suggest that self-employed Americans and non-corporate small businesses account for about eight times as much underreported income taxes as corporations with at least $10 million in assets.
A study that the Treasury Department cited in 2021 found that “compliance rates at the top of the income distribution are significantly higher than at other points.”
But a campaign arguing for doubling the size of the IRS to crack down on waitresses, gig workers, and small businesses would have been a public relations nightmare. So, instead they sold us on the fantasy that the government could dramatically increase spending, but 98% of Americans wouldn’t be asked to pay another dime.
So, how can the IRS square its past claims with its current actions?
It points to the fine print.
The proposed tip-reporting changes illustrate a few ways the IRS can make middle-class and small businesses pay more in taxes without technically increasing audit rates on people making less than $400,000.
If the IRS thinks that waitresses are underreporting their tips, the agency doesn’t have to audit the waitresses, it can instead pressure the restaurants into doing its dirty work for it.
If the restaurant doesn’t give the IRS detailed reports that show what it wants to see, then the agency can subject the business to a compliance review.
The IRS defines a compliance review as “a review or other inspection of a Service Industry Employer’s books, records and filed federal tax and information returns [related to its participation in the tip-reporting program].”
Now, that may sound a bit like an audit to you, but the IRS has its bases covered. In the same definition, the IRS stipulates that compliance reviews are not audits or examinations.
The IRS can use the power to define what does and doesn’t count as an audit to help prevent audit rates on middle-income Americans and small businesses from rising.
Even if compliance reviews were counted as audits, many would be performed on restaurants and businesses with more than $400,000 of income per year, meaning the IRS wouldn’t count those as audits of “small businesses.”
The IRS and the White House know this arbitrary $400,000 cutoff is a very narrow definition of small business. The IRS itself classifies businesses as small businesses if they have less than $10 million of assets.
Despite the rhetoric, the IRS always intended to leave the door open to going after everyone from local shop owners to delivery guys to roofing companies to waitresses.
Voluntary compliance is the key to tax collections, and public trust is a necessary part of achieving it. The IRS has deeply damaged public trust by participating in a bait-and-switch.
It is incumbent on the incoming IRS commissioner to restore that trust by being straight with the American people, and Congress must hold the IRS to that standard.
Have an opinion about this article? To sound off, please email letters@DailySignal.com and we’ll consider publishing your edited remarks in our regular “We Hear You” feature. Remember to include the url or headline of the article plus your name and town and/or state.