Everything Restaurants Need to Know About IRS Tip Reporting
Restaurant employers and employees have specific reporting responsibilities when it comes to tips.
DISCLAIMER: This content is provided for informational purposes only and is not intended as legal, accounting, tax, HR, or other professional advice. You are responsible for your own compliance with laws and regulations. You should contact your attorney or other relevant advisor for advice specific to your circumstances.
A deeply debated and contested issue, tips play a huge role in the payment of restaurant employees, especially those in the front of the house. This is why IRS tip reporting is hugely important to almost every restaurant business.
One of the most important factors that restaurant employers and employees should both be aware of is that tips are considered taxable income. Because of this, employees and employers each have specific reporting requirements.
Read on to see what the IRS requirements are and how they impact your restaurant.
A Restaurant Employee’s Responsibilities for Tip Reporting
First off, a tipped employee is an individual who regularly earns $30 or more per month in tips.
Federal standards require that every tipped employee do the following:
1. Keep a daily record of both cash tips (cash and credit) and non-cash tips (movie or concert tickets, etc.).
Non-cash tips are reported on the employee’s personal income tax. Employees are not required to report non-cash tips to their employers. As such, the reporting format only needs to account for the date each non-cash gift was received along with an annual total.
2. Report monthly tipped earnings of $20 or more to employers by the 10th day of the following month.
If the 10th falls on a weekend or holiday, the report is due the next business day. While employers can require more frequent reporting, the largest period of time one report can represent is one month.
3. Report tipped income within their personal income tax return and use Form 4137 to document any allocated tips.
Allocated tips are the result of when a large employer (with 10 or more employees) has a day when the total reported tips (from employees) is less than 8% of the gross receipts. In this instance, the employer must then make up the difference by distributing the appropriate dollar amounts among the tipped employees.
How to Keep a Daily Tip Record
Restaurant servers, bartenders, hostesses and other tipped employees may use:
- IRS Form 4070.
- A simple pen and paper report, as long as it contains the employee’s:
- Legal name
- Current address
- Social security number
- Time period covered
- Total amount of tips
- Smartphone apps, like:
How Point-of-Sale Systems (POS) Can Help with Tip Reporting
With modern POS systems, any tips added at payment with a credit or debit card will be logged by the restaurant’s POS system - giving management and employees accurate totals for these amounts.
Reporting Responsibilities for Restaurants With Tipped Employees
Restaurants with tipped employees have to document that they are complying with both labor and tax laws. In other words, employers have to pay tipped employees the correct amount and, in turn, account for the appropriate amount of payroll taxes.
Here’s a simplified version of how this works.
The Tip Credit
The main way in which restaurants must prove that they’re following the labor laws is through the application of the server tip credit, a method that lets employers count employee tips as part of the hourly minimum wage.
Under federal standards, an employer can claim up to $5.12 per hour as a tip credit. This is calculated by subtracting the $2.13 minimum required cash wage from the $7.25 federal minimum wage.
When overtime kicks in, this repeats itself, factoring in the federal overtime rate of $10.88. That said, many states have their own minimum wage and overtime laws with higher maximum and minimum wages that employers are required to follow.
In order to take advantage of the tip credit, an employer must first make sure that the employee is aware of how to the tip credit works and what the minimum and maximum wages will be. Employees can be informed through onboarding conversations as well as printed documentation, such as wage and hour posters.
Payroll and Payroll Taxes
The hours worked, rate of pay, and tax rates all come together as a part of the restaurant payroll process.
While rate of pay is determined by minimum wage laws, the total amount paid is subject to payroll taxes (also known as employment taxes), which include income tax, unemployment tax, Medicare, and social security.
Income tax amounts are withheld (deducted) and then paid by the employer to the IRS. The employer withholds the employee’s Medicare and social security amounts while contributing an equal amount, and the unemployment tax is paid in full by the employer.
In terms of reporting, this means employers must:
- Retain the monthly tipped income reports from employees.
- Report all of the wage, income tax, and payroll tax amounts in year-end W-2s that are due January 31.
- File Form 941 (Employer’s Quarterly Federal Tax Return) due January 31, April 30, July 31 and October 31.
- File Form 940 (Employer’s Annual Federal Unemployment Tax Return) due January 31.
The process repeats in a similar fashion for state and local taxes, especially in relation to income tax and unemployment. A majority of states have an income tax and every state has an unemployment tax. This interactive, state-by-state tax map gives you a detailed summary of how federal, state, and local taxes come together.
Who’s Responsible for Enforcing Tip Reporting?
As the rules stand right now, it’s the employee’s responsibility to report the tips to the employer. All the employer is required to do is administer the payroll taxes once the tips are reported.
That would be the IRS. If they suspect that an employer has failed in their tip reporting duties, the response would be a series of warnings followed by an audit. If it’s found that an employer has intentionally misreported tipped income, the employer can be fined up to $10,000.
A Few Closing Thoughts
In addition to the information above, the following notes are also worth keeping in mind:
- Tips are the property of the employee — They only exception is when the tipped employees are participating in a valid tip pool.
- The difference between service charges and tips — Service charges, like a certain percentage added onto a check for a large party, are not considered tips. Employees should not report them as tips and employers must classify service charges as non-tipped wages. (However, non-tipped wages are still taxable wages and subject to payroll taxes.)
- The rules on credit card service charges and tips — Under current Fair Labor Standards Act (FLSA) guidelines, employers may charge employees a small fee of up to 3% on tips received through a credit card payment in an effort to recoup the costs of the service charges. But, this fee can only be applied as long as it doesn’t lower the employee’s rate of pay below the required minimum wage.
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