Hi! Welcome to Just Answers! Thank you for the opportunity to answer your question. I am sorry to hear that her employer is not reporting her tips. Unfortunately, as you stated, this is common in this industry!
If she is aware that the tips are not being reported in her wages, she needs to file Form 4137 with her tax return and pay the Social Security and Medicare taxes on it, as well as income tax. Even though she is reporting them to her employer, they are not being reported to Social Security or the IRS. Since she is aware of the situation, she is liable for the taxes on this income. It is better that she volunteer the tax than to have the IRS come after her for it.
As far as reporting the employer, the IRS does encourage whistle blowing. The IRS' Criminal Investigation Division will look into it.
The IRS may pay awards to people who provide specific and credible information to the IRS if the information results in the collection of taxes, penalties, interest or other amounts from the noncompliant taxpayer. They are looking for solid information, not an "educated guess" or unsupported speculation. They are also looking for a significant Federal tax issue - this is not a program for resolving personal problems or disputes about a business relationship.
The law provides for two types of awards. If the taxes, penalties, interest and other amounts in dispute exceed $2 million (I doubt yours would), and other requirements are met, the IRS will pay between 15% and 30% of the amount collected. If the case deals with an individual, his or her annual gross income must be more than $200,000. Depending on what type of establishment it is (corporation, sole proprietor, partnership, etc.) this may be possible. You can call the IRS' fraud hotline at 1-800-829-0433 to report this problem.
Even if you don't get any "reward" for turning him in, it will give you satisfaction knowing that he isn't taking your money anymore!
I hope this answers your question! If it doesn't, or if you have any more, please ask away! If it does, please rate me positively!
In the future if you wish to ask me any questions, you can request me.
Thanks! Have a great week, or what's left of it!