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Reporting Tips – Your Obligations

MassPay works with many restaurants and food service establishments. These businesses often turn to MassPay for guidance on reporting tips. Questions typically center on the following:

  • What are employees required to report?
  • When must employees report tips?
  • What does the employer withhold?
  • How does the employer report tips?
  • What is the minimum allocation for tips?
     

We cover these items in brief, but you should also check with your accountant and legal counsel to make sure you are in compliance with reporting tips.

What are employees required to report?

Employees are required to report all tip money received. According to the IRS, tips include cash left by customers, tips that customers have added to their debit or credit card charges, and tips that the employee receives from other employees (split/pooled tips*).

* Pooled tips have been the subject of many lawsuits recently. Tip pooling laws can vary state by state, but generally, only service workers are eligible to receive pooled tips (i.e. waitstaff, bartenders, hostesses, etc). “Back of the house” workers are ineligible. It is very important that no members of management or ownership benefit financially from pooled tips.

When must employees report tips?

Tips must be reported for any one month by the 10th of the month afterward. This is required for tips that total $20 or more every month, regardless of total wages and tips for the year. However, you need a report for each payroll period (typically weekly) in order to report proper wages and withhold the proper taxes, so more frequent reporting is needed.

Employees should record their tips daily using Form 4070A and Form 4070.

Sample form for recording tips by the employee (detailed):

IRS Form 4070A for Employee Tip Reporting

Sample form for recording tips by the employee (summary):

IRS Form 4070 for Tip Reporting - Summary

Note that the employee must sign this form!

Today’s POS (Point Of Sale) or register systems make this process much easier. These systems typically allow employees to enter their cash tips, which should be done at the end of their shift before they clock out.

POS systems can be used to collect and report tips

Tip reporting also includes tips from credit/debit cards, bur this is already recorded by the system and is reported in a separate section of Form 4070.

What does the employer withhold?

Income tax and FICA tax will be withheld from the employee’s paycheck. Your payroll service will need to know the tips reported for the period (cash & credit/debit), total hours worked and the employee’s hourly rate.

At MassPay, our restaurant clients report this information through iSolved payroll, before processing their payroll. The payroll system then calculates the required taxes, generates the paychecks and provides reports and other necessary documentation.

How does the employer report tips?

Employers need to file an annual report, IRS Form 8027, at the end of each year, if they meet these conditions:

  • Tipping is customary in your restaurant
  • Food & beverages are served
  • More than 10 employees
     

What is the minimum allocation for tips?

Employers must ensure that the total tip income reported to you during any pay period is, at a minimum,equal to 8% of your total receipts for that period.

In calculating 8% of total receipts, you do not include non-allocable receipts, defined as receipts for carry out sales (take out) and receipts with a service charge added of 10% or more.

If the total reported to you is less than 8%, you must allocate the difference between the actual tip income reported and 8% of gross receipts.

Employers can request a lower rate (but not lower than 2%) for tip allocation purposes by submitting an application to the IRS. Detailed instructions for computing allocation of tips, reporting allocated tips to employees, and for requesting a lower rate can be found in the Instructions for Form 8027. (PDF)

The most common methods to allocate tips include:

Gross Receipt Method

This method can be used by any restaurant and usually results in a more accurate and fair allocation. It determines the amount that each server should have reported in tips to reach the 8% minimum threshold by comparing the server’s gross receipts as a percentage of the total restaurant receipts. If the server’s actual reported tips are less than the percentage calculated, then a prorated portion of the total shortfall is allocated to that employees’ W-2.

Hours Worked Method

This method only applies to restaurants which employ fewer than 25 full time employees during a payroll period, and it allocates any tip shortfall (below 8% of total sales) by spreading it among under-reporting servers, based on their percentage of total hours worked, as compared to all the other servers. This method is the least accurate as it does not take into account the fact that servers work shifts with different tipping patterns.

You are not required to withhold income or Social Security taxes on the allocated tip income. The amount of tip income allocated to each employee is shown in box 8 of their Form W-2.

Establishments that employ fewer than the equivalent of 25 full-time employees (both tipped and non-tipped employees) during a payroll period may use the hours-worked method to allocate tips. You will be considered to have employed fewer than the equivalent of 25 full-time employees during a payroll period if the average number of employee hours worked (both tipped and non-tipped employees) per business day during a payroll period is less than 200 hours.

Summary

It’s vital that you educate and train employees on the importance of reporting tips – 100% of tip income.

As a business, you will be responsible to ensure that at least 8% of gross sales has been reported in tips by employees. Remember that this is a threshold, and is not to be used as a target. In fact, this is one way that the IRS monitors compliance and can flag you for an audit.

MassPay can help you revise your employee handbook, set up your tip reporting procedures and train employees about reporting their tips so you’ll stay in compliance and out of hot water with the IRS. See HR Servi ces to learn more.

Background Sources:

IRS: Reporting Tip Income – Restaurant Tax Tips

Restaurant Resource Group: What Employers need to Know About Tip Reporting