Basic tip reporting requirements

Cash tipping is often a major source of income to restaurant employees. Employers should have an employee manual, which includes a tip reporting policy setting a process for how to document tips at the end of each shift.

Often, restaurant employees mistakenly believe tip earners only need to report tips equal to 8 percent of restaurant sales; however, employees must report and pay taxes on 100 percent of the tips they keep.

The IRS states employees who receive tips that total $20 or more in a month must report the tips to their employer by the tenth of the following month. To prove their annual tip income, employees should have sufficient proof, keeping daily logs or other evidence of all credit card and cash tips, whether received from customers or other employees. Records should also be kept showing the names and amounts of tips paid to other employees through tip sharing or other arrangements.

Employers are required to withhold income, Social Security, and Medicare taxes on these reported tips. Please reference Publication 1244 “Employee’s Daily Record of Tips” (Form 4070A) for an example of the type of information that should be recorded on a daily basis. Publication 1244 also includes “Employee’s Report of Tips to Employer” (Form 4070). The statement must be signed by the employee. Use Publication 531 “Reporting Tip Income” as a reference or distribute it to your employees to educate them on the rules of tip reporting.

If tips of $20 or more for any month are not reported to the employer, the employee must include those tips on his or her individual income tax return. The employee must also calculate and pay Social Security and Medicare taxes on these unreported tips when filing. If employees do not report or appropriately account for tips on their individual tax return, they may be charged a penalty of 50 percent of the Social Security and Medicare taxes due on the unreported tips—unless there was a reasonable cause for not reporting them. This penalty amount is in addition to taxes that are owed.

Beginning Jan. 1, 2014, any service charge (automatic gratuities) that the employer adds to a customer’s bill and then pays to the employee should be treated as wages and not included in the tip diary. 

In addition to distributing the abovementioned IRS publications, employers should periodically inform employees about these requirements and document their efforts in their corporate files. This will help prove the employer, in good faith, has educated their employees and can be referenced if the employer is ever audited by the IRS.

In industries where tipping is common, employers understand they must pay their share of Social Security and Medicare taxes on tips which employees report to them. However, many employers do not realize they may be liable for the employer share of taxes on tips employees do not report to them until the IRS issues a notice and demand and/or upon IRS audit.

In order to protect themselves and their employees, employers must take a proactive role in educating employees on the importance of accurately reporting their tips.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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