Payroll accounting can be complex for any industry, but for restaurants, it can get particularly sticky. No other industry utilizes tipping as pay as much as restaurants do. Staying up to date on tip reporting best practices and abiding by tip reporting rules can help keep the process problem-free and IRS-compliant.
A tipped employee is any worker who regularly receives more than $30 a month in cash tips. Restaurant owners and operators are federally mandated to pay $2.13 per hour in direct cash wages to their tipped employees. The remainder of the federal $7.25 hourly minimum wage can be accounted for through tips. If tips received do not combine to amount to the federal minimum wage, the operator must pay the difference. The state in which the restaurant operates is also a factor. In states with a higher minimum wage threshold, the restaurant must meet that state’s minimum wage. Some states cap the amount of minimum wage tip credit that can be claimed, and other states do not allow a tip credit at all. (The minimum wage tip credit is explained in detail below.)
Owners and employees in management roles may not retain any tips intended for employees. Managers and supervisors may receive tips in certain situations, but only if that tip is paid to them directly for services they solely provided. Managers, supervisors and owners are also prohibited from participating in tip pools. Even though they are employees of the restaurants, they are not customarily tipped employees and therefore cannot take part in a tip pool arrangement.
Traditional tip pools are comprised of employees who customarily and regularly receive tips. At the end of the business day, employers must fully distribute all tips received. The allocation of tips to the participating employees should be based on hours worked, a point system, or another method that is reasonable and equitable.
Employees must be notified that they are participating in a tip pool, as well as the details of how the tip pool will be administered. A best practice would be to include tip pooling procedures, terms and conditions in an employee handbook given to new hires as part of the onboarding process.
Tip pools include traditionally tipped employees, as well as non-customarily tipped employees such as dishwashers and cooks. Management is specifically excluded from tip pool participation, including a non-traditional tip pool. In order to operate using a non-traditional tip pool, all employees must be paid the full cash minimum wage (so no minimum wage tip credit). Ownership is also prohibited from claiming the FICA tip credit if a non-traditional tip pooling arrangement is in place.
Tip sharing differs from tip pooling in several ways. In tip pools, all tips are collected into one pot and distributed according to a reasonable formula that employees have agreed to participate in.
Tip sharing is strictly voluntary. It is simply an agreement between employees to share tips with back-of-house staff, and is operated by the employees, not the employer. These agreements are not regulated by tip pooling rules or Department of Labor laws.
Restaurants will often include an auto gratuity for large parties, typically 20%. Auto gratuities are not treated as tips, but rather are considered service charges. While this may vary by state, generally if the service charge is fully paid out to employees, it will not be considered taxable income to the restaurant. However, if all or part of the auto gratuity is not dispersed to employees, the amount retained by the restaurant is considered taxable income and in some cases may also be subject to sales tax.
Like wages, employee tip income must be reported to the IRS as part of a restaurant’s quarterly payroll tax filing. Form 941 is filed quarterly and includes total wages paid, tips reported, and Social Security and Medicare taxes paid by the employer and withheld from employee paychecks. Restaurant businesses that employ more than ten employees (tipped and untipped) will also need to file an annual form 8027. Form 8027 totals receipts and tips for restaurants and can be used to calculate allocated tips if necessary.
Accounting for tips can get messy and time-consuming. The more restaurants can automate through software, the better. Restaurant point-of-sale systems have mechanisms built in to track tips, making compliance reporting easier and more accurate. Investing in restaurant accounting software is another tip reporting best practice worth considering.
The FICA tip credit is a mechanism that allows employers to claim a dollar-for-dollar tax credit for their share of Social Security and Medicare taxes paid on tipped wages in excess of the
minimum wage, which for purposes of this credit, is the old federal minimum wage of $5.15. The credit is calculated and reported annually with the restaurant’s tax return on Form 8846.
To qualify for the credit, restaurants must have employees who received tips from customers for providing, delivering or serving food or beverages for consumption and paid or incurred employer Social Security and Medicare taxes on those tips.
The credit is available only on tips received by food and beverage employees, and not on any other tipped employees. For example, the credit cannot be applied to tips received by valet workers, or any other non-food and beverage employee.
If your restaurant is claiming the tip credit against cash minimum wages, you must abide by the 80/20 rule. The purpose of the rule is to limit the amount of non-tipped work performed by tipped employees so that they have ample opportunity to earn their minimum wage, or higher, through tip-producing work.
Under the 80/20 rule, there are two categories of work – tip-producing work, and tip-supporting work. Tip-producing work is tasks that one would be customarily tipped for, such as serving food and drink. Tip-supporting work could include tasks such as setting tables, rolling silverware, or closing activities. The rule states that at least 80% of a tipped employee’s time should be spent performing tip-producing work. Additionally, of the maximum 20% of time that can be spent performing tip-supporting work, such work should not be performed for more than 30 consecutive minutes.
Tip accounting and disbursement is an area restaurants need to take special care with. Improper or inaccurate reporting can create problems with the IRS, state tax authorities, and Departments of Labor. Being diligent with reporting requirements and implementing fair and transparent disbursement policies will mitigate the likelihood of running into trouble. A Baker Tilly tax professional can help.
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.