Eight tips for employers and employees about reporting tips

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Tip-Reporting Basics

Eight tips for employers and employees about reporting tips.
Last updated February 2002

What you need to know if you earn tips ...

1. 100% is the magic number: All tips are taxable.
If you earn tips, be aware that if you receive more than $20 in a month in tips, ALL these tips count as income that you must report and pay taxes on. That includes your cash tips, your charge-card tips, and any tips you get from other employees, minus what you tip out to others.

You may have heard all you need to do is report tips equal to 8% of sales, or 10%, or just your charge-card tips. That's a big misconception, and could get you in legal trouble if you earn more. The law requires you to report and pay taxes on 100% of the tips you keep after tip-outs. See more on the "8% myth", below.

2. Employees must record their tips daily.
If you get audited, there's only one thing that'll save you: good daily records. The IRS requires tipped employees to keep a daily tip diary or other evidence to prove tip earnings. Your daily records must show how much you made in cash tips and charge-card tips; the amount of tips you received from other employees through tip pools or other tip-sharing arrangements; and the amount tipped out to other employees.

While you're not required to use the IRS's forms to keep track of your tips, the IRS offers Form 4070A, Employee's Daily Record of Tips, that you can use as your personal tip diary. Call the IRS at (800) TAX-FORM 

3. Employees must report their tips to their employer.
Anyone who receives $20 or more in tips in a month must report all tips to their employer by no later than the 10th day of the following month. (Employers may require employees to report tips more often, like every week or at the end of every shift.)

This requirement applies both to directly-tipped employees, such as servers who get tips directly from customers, as well as to indirectly-tipped employees, such as busers, who may share in these tips. An employee's written tip report must include certain information: Check out IRS Form 4070, Employee's Report of Tips to Employer, for details. 

4. Not reporting your tips is a big deal.
If the IRS audits you and finds out you didn't report all your tips, you could be facing some big bills. Falsifying tip income is illegal. You'll owe income and FICA (Social Security and Medicare) taxes on the unreported tips. You'll probably be stuck with interest and penalties. What's more, the IRS has the right to audit at least as far back as three years -- or further, if the agency believes it's a case of fraud. Some restaurant servers have even been jailed for tax evasion.

What you need to know if you employ tipped workers ...

1. You are required to gather employees' tip reports.
The IRS requires any employee who receives more than $20 per month in tips to report those tips to his or her employer at least once a month. Tip reports are due to employers by no later than the 10th of the month for the previous month's tips. Employers can require reports even more frequently, such as at the end of every shift, every day, or every week. The IRS requires specific information in employee tip reports. IRS Publication 1244, Employee's Daily Record of Tips and Report to Employer contains a form employees can use. Download the publication in English (PDF) or Spanish (PDF) from the IRS Web site.

2. You must report your employees' tips to the IRS and withhold taxes.
Employers are required to pay the employer's share of payroll taxes on tips, plus withhold all the required income and FICA and other payroll taxes on wages and reported tips from wages actually paid the employee.

At the end of each year, employers are required to total each employee's reported tips for the year and record this amount on the employee's W-2 form as "wages," along with cash wages. In some cases, employers will also be required to "allocate" tips to certain employees on employees' W-2 forms if they have not reported a sufficient amount of tips; read on for more information.

3. Certain employers must file Form 8027 with the IRS -- and, in some cases, "allocate" tips.
If your restaurant meets three criteria -- (1) tipping is customary in your establishment, (2) you serve food and drink for on-premises consumption, and (3) you employ more than ten employees or their equivalent (more than 80 employee hours) on a typical day -- you must file IRS Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, with the IRS each February. On this form, you report annual totals for your restaurant's sales, charge-card sales, charge-card tips, and reported tips.

If you are an 8027 filer and the total tips your employees report for the pay period or the year don't add up to 8% of your restaurant's sales, you must also go through what's called "tip allocation." This process -- which points the IRS toward restaurants where employees may not be reporting all their tips -- requires you to "allocate" tips to any directly tipped employees who reported tips of less than 8% of his or her sales. You do not withhold taxes on allocated tips. You simply show total allocated tips on your Form 8027, and note the allocations to specific employees on their W-2 Forms. Allocation can get complicated: Check the Form 8027 

4. A word to the wise: Employers, educate your employees!
No restaurateur wants to be in the business of policing employees' tip reports, since it's the employees' responsibility to report and pay taxes on their tips. However, there's good reason for employers to make sure employees understand 100% tip reporting: Underreporting can make both you and your employees vulnerable to an IRS audit. The law says employers owe FICA taxes on all the tips their employees receive, whether they are reported or not.

The 8% Myth
Many restaurant employers and restaurant employees may have heard the false rumor that tip-earners only need to report tips equal to 8% (or perhaps some other number, such as 10%) of their sales. That's a widespread misconception. The law requires employees to report and pay taxes on 100% of the tips they keep after tip-outs. It's that simple.

The 8% figure is simply a threshold below which many employers must allocate tips and report certain additional information to the IRS. The IRS can use this information to flag restaurants where employees may be underreporting tips.



The $0 Paycheck Problem
When employers withhold taxes from tipped employees' paychecks, they base the amount withheld on both the tip income and cash wages employees receive. Sometimes tipped employees' paychecks may not be big enough for the employer to withhold all the required income and payroll taxes. In this "$0 paycheck" situation, here are a few tips for employers and employees:

  • Employers: Be sure you are withholding all taxes in the proper order. State and federal laws set a particular order for withholding taxes. Check with your accountant or payroll service to make sure you're doing it right.

  • Employers: Let your employees know that you weren't able to withhold all the required taxes. They may want to set aside some extra money, or give you extra funds to apply toward these taxes, so they don't get socked at tax-time with a bigger tax bill because not enough taxes were withheld throughout the year.

  • Employers: If you're not able to withhold the full amount of federal FICA (Social Security and Medicare) taxes due on reported tips, you are required to note this as "uncollected Social Security taxes on tips" on the employee's W-2 form.

  • Employees: If you're receiving $0 paychecks, be aware that you may owe more in taxes than you expect when you file your returns in April. Some tip-earners save a few extra dollars over the year so they don't get caught short at tax time. Better yet, many tipped employees give extra money to their employers to apply to their tax withholding. This helps avoid any estimated-tax penalties.


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