Employers who own businesses where employees receive tips have multiple obligations with regard to the employee tip income including recordkeeping and reporting responsibilities, withholding taxes on tips, filing certain forms, and paying or depositing taxes.
If you are a business owner whose customers routinely tip your employees (e.g. restaurant, hotel or lodge, hair salon or barber shop, tour company), then you need to be aware of your responsibilities for reporting and paying tax on those tips.
COLLECTING TIP INFORMATION FROM EMPLOYEES
Employees who receive cash tips of $20 or more in a calendar month while working for you, are required to report to you the total amount of tips they receive. The employees must give you written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to you but must report these amounts as income on their tax returns and pay taxes, if any.
Employees can report their tips to you on their own handwritten form, by electronic means or by using IRS Form 4070. The submitted form must include their name, address and social security number; your business name and address; the month or period the report covers; and, the total tips received. You can require that tip information be reported more often – at the end of each pay period for example – but the tip report should not cover a period of more than one month. It also must be signed by the employee.
You are not responsible for verifying the accuracy of the amount of tip income your employees report to you but you are responsible for collecting the information from your employees. If an employee does not report tips to you, you can be held liable for the employer’s portion of Social Security and Medicare taxes as determined by the IRS. Employers are required to retain the employee tip reports as part of their accounting records.
WITHHOLDING PAYROLL TAXES
The tip income that your employees report to you must be included in their regular paychecks and assessed usual payroll taxes: Social Security, Medicare, and federal and state income taxes. You can collect these taxes from the employee’s wages or from other funds that he or she gives to you.
If you don’t have enough money from the employee’s wages and/or funds that they give to you, then withhold taxes in the following order:
- Social Security and Medicare taxes on the employee’s wages,
- Federal income taxes on the employee’s wages,
- State and local taxes imposed on the employee’s wages,
- Social Security and Medicare taxes on the employee’s reported tips, and
- Federal income taxes on the employee’s reported tips.
If the employee’s paycheck is not sufficient to cover the payroll taxes, you must record the amount of the uncollected taxes and withhold them from their next regular paycheck up to the close of the calendar year. But if you cannot collect all of the employee’s Social Security and Medicare taxes on tips by the 10th day of the month following the month in which your employee reported the tips, you do not have to collect the taxes.
Show the uncollected amount as an adjustment on your employment tax return (Form 941, Employer’s Quarterly Federal Tax Return). Also, be sure to report the uncollected Social Security and Medicare taxes in the appropriate box on the employee’s Form W-2, Wage and Tax Statement. You may want to inform your tipped employees that if all the federal and state payroll taxes on their wages and tips will not be collected by the end of the year, they may need to make estimated tax payments. If an employee does not pay enough tax throughout the year, either through withholding or by making estimated tax payments, they may be subject to a penalty for underpayment of estimated taxes. Refer your employees to Publication 505, Tax Withholding and Estimated Tax, for additional information.
ALLOCATING TIPS
The IRS has special requirements for the reporting of tips by large food and beverage establishments. A large food or beverage establishment is defined as a business where all of the following apply:
- Food or beverage is provided for consumption on the premises
- Tipping is a customary practice
- More than 10 employees, who work more than 80 hours, were normally employed on a typical business day during the preceding calendar year.
If you operate a large food or beverage establishment, you must file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, at the end of each calendar year and may be required to allocate tips to your employees. (A worksheet for determining whether a business meets the criteria listed above is included in the instructions for IRS Form 8027.)
If, at the end of the year, the total amount of tips that all of your employees reported to you throughout the year is less than 8 percent of your gross receipts for the year, you are required by the IRS to allocate the difference (between what was reported and what is calculated to be 8% of gross receipts) among all of your employees who received tips. You can base the allocation on each employee’s share of gross receipts or share of total hours worked, or on a written agreement between you and your employees. But you must allocate the amount.
You are required to report the amount allocated on Form W-2 in the box labeled “Allocated Tips” for each employee to whom you allocated tips. The amount shown as allocated tip income is for information purposes only. You are not required to withhold income or Social Security taxes on the allocated amount.
If you meet the criteria for filing Form 8027 but do not file, the law provides for penalties for each failure to timely file a correct information return, including failure to file electronically, if required. Penalties may be imposed for both failing to file and failing to furnish a correct Form W-2 for each form on which you fail to include this required information.
Whether or not you are required to allocate tips, your employees must continue to report all tips to you, and you must use the amounts they report to figure payroll taxes.
REPORTING TO THE IRS
Tip income is reported to the IRS quarterly on Form 941 and annually on Form 940 and the employee’s W-2. In addition, large food and beverage establishments are required to file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips. If there are still uncollected Social Security and Medicare taxes at the end of the calendar year, these amounts are reported in Box 12 of Form W-2.
Any business in which the employees customarily receive tips is subject to a Tip Examination by the IRS. Employment tax tip examinations are initiated when the IRS determines that the employer is reporting low or zero tips on its Form 941 or Form 8027. If it is concluded that tip income has been under-reported, the IRS will determine the amount of the under-reported tips and your business will be liable for the employer share of Social Security and Medicare taxes on the under-reported tips.
In addition, once a tip examination has been initiated, the IRS auditor can examine other common employment tax issues such as unreported compensation and worker classifications.
You can create a paper form or an electronic form (such as an Excel spreadsheet) for your employees to use to report their tips to you. You can also obtain Publication 1244 from the IRS which contains Form 4070-A, Employee’s Daily Record of Tips and, Form 4070, Employee’s Report of Tips to Employer. Whichever way you do it, it’s your responsibility to ensure that your employees are reporting their tips to you. It could be the key factor to mitigating any issues that arise if you’re subject to an examination or avoiding an examination all together.