TC 310: Penalty for Failure to Report Tip Income

What the code actually does

TC 310 assesses the penalty under IRC 6652(b). IRS Document 6209, Section 8A describes it as assessing a “penalty for taxpayer’s failure to report Tips Income,” and it is an individual-account code. IRM 20.1.10.6.2 explains the underlying duty: the penalty falls on employees who fail to timely and properly report tips to their employer as IRC 6053(a) requires, unless the failure was due to reasonable cause and not willful neglect.

The reporting rule it enforces is specific. Every employee who receives $20 or more in cash tips in a calendar month must report them to their employer in writing, generally by the 10th day of the following month. Charged tips distributed by the employer and tips received through a sharing arrangement count; non-cash tips such as passes or tickets do not, though they remain taxable income. And where someone works for several employers and receives under $20 from each in a month, no report is required to any of them.

The rate is 50 percent of employment tax, not of the tips

The computation is the most misunderstood part, and getting it wrong overstates the exposure badly. IRM 20.1.10.6.2.1 states that “the penalty is 50 percent of the tax imposed by IRC 3101, Rate of Tax (social security tax, Medicare tax, and Additional Medicare Tax) or IRC 3201, Rate of Tax (RRTA) due on the amount of unreported tips.” The base is the employee’s share of the employment tax on the unreported tips — not the tips themselves and not the income tax on them.

So on unreported tips the penalty is roughly half of the 7.65 percent employee share, in the region of 3.8 percent of the tips, before any additional Medicare tax. A client told they face a penalty of half their unreported tips is being quoted a figure many times the real one. The IRM adds a detail that explains where the charge shows up: the penalty, “though calculated based on an employment tax, is assessed and collected as a part of the taxpayer’s income tax,” which is why it appears on an individual income tax module rather than an employment tax one.

Two procedural features that surprise people

The first is that there is no notice of deficiency. IRM 20.1.10.6.2.2 records that the penalty is “not subject to deficiency procedures,” citing Judd v. Commissioner, 74 T.C. 651 (1980). It is assessed on IDRS against MFT 30 with reference code 891 or 892 carrying the money amount. That removes the Tax Court petition route that clients and practitioners instinctively expect from an examination-driven adjustment, and it means the response has to be made administratively.

The second concerns timing, and it can be genuinely alarming. The same subsection explains that where the employee did not file Form 4137 or otherwise include the FICA tax on the return, “the statute is open for the FICA tax on the unreported tip income. Therefore, FICA tax on unreported tips and the FICA tip penalty can be assessed even if the statute of limitations has expired for income taxes,” citing Rev. Rul. 79-39. A year a client reasonably believes is closed is not closed for this purpose. Conversely, where income tax and FICA tax were both reported on the return, the IRM states the statute for the additional FICA tax and the penalty is the same as for the income tax — so whether Form 4137 was filed is the fact that decides which regime applies.

What TC 310 gets confused with

TC 310 gets confused with the underlying tax on the unreported tips, which is a separate assessment. The FICA tax itself is one liability and this penalty is another, computed at half of it, and a client can face both from one omission. Reading the penalty line as the tax, or as including it, understates what is owed.

It is also mistaken for an accuracy-related penalty, since both arise from income left off a return and both surface through correspondence examination. They are different provisions with different bases and different relief paths — the accuracy-related penalty runs at 20 percent of an income tax underpayment and posts by penalty reference number, while this one runs at 50 percent of an employment tax figure and has its own transaction code. It is also unrelated to the civil fraud penalty at TC 320, notwithstanding that unreported cash income is a common setting for both.

The practitioner’s actual next step

Recompute the penalty against the employment tax base rather than the tips, because the 50 percent figure applies to a much smaller number than clients assume.

Establish whether Form 4137 was filed, since that determines whether the assessment period follows the income tax statute or remains open independently.

Do not plan on a deficiency notice or a Tax Court petition — the penalty is assessable, so the response is administrative from the outset.

Prepare the reasonable-cause statement in the form the IRM requires: a written statement setting out all the facts alleged as reasonable cause, made under penalties of perjury if it responds to a proposed assessment notice, with any abatement posting as TC 311.

Separate the tax from the penalty when advising on payment, and confirm what has actually been assessed on the module with the IRS Transcript Decoder before quoting a total.