Between cash & credit tips, tip pooling, regular wages and tax compliance payroll for restaurants is quite complex. We know tipped employees want to maximize their tips and restaurant owners and managers want their employees to be happy, while meeting all tax requirements. After all, good employee management starts with good managers.
This restaurant payroll guide covers the foundation of what you need to know and the tools you need to help you if:
Employers are allowed to pay an hourly rate that’s lower than the minimum wage if it’s expected that employees will easily make up the difference in tips. Employees that don’t receive tips, however, need to be paid at or above the minimum wage. Check your local laws for the latest wage rate, as it can be higher than the federal minimum.
Tips are customary practice in most restaurants but keep in mind that it is voluntary. They are not taxable if they don’t exceed the amount of $20/month. If the employee receives more than $20 a month in cash tips, he or she must report the amount to the employer, and the income received is considered as wage and taxed accordingly.
These are tips added directly to the bill by the restaurant that issues the bill. The customer is not allowed to adjust these fees the way they would in non-compulsory tips. Service charges are considered non-tips and are taxed as regular wages, which are subject to payroll tax withholding. Keep in mind that tip calculations on a customer’s receipt are not service charges.
These tips are applied to the bill receipt. The customer adds the tip amount to the total cost of the meal or beverage. The credit card is then charged for both the tip and meal cost. Employers can choose to pay the credit card tips in cash or pay them with the next scheduled payroll. Processing fee deductions from tips vary from state to state.
Although employers should keep records of non-cash tips received, like sporting-event tickets or gifts, there’s no withholding for non-cash tips. Employees, however, must pay income taxes on all tips, whether received in cash, credit card or non-cash.
Tip pooling is the practice of tipped employees contributing a certain amount of received tips to a collective pool. This pool of funds is then divided evenly among those employees. Tip pooling may not detract from the minimum wage requirement, even if employers take the tip credit which allows for employees to be paid less than the federal minimum wage because they are a tipped employee.
An employee is only disallowed from sharing in tips if all of the following are true:
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Make sure to calculate and pay all of the applicable FICA and payroll taxes, like Medicare and Social Security. You are required to collect these taxes from the employee based on their total earnings, including tips. You are also required to pay the same amount in FICA taxes per employee.
Talk with your CPA about the possibility of recouping some of the excess FICA taxes you are paying for your tipped employees. You may be eligible to file for a FICA tip credit on your business taxes. If so, a reliable method of tracking your tips will be required to apply for the credit. Some of the rules and requirements can seem confusing. Consult with your payroll processing company with any questions you may have.
In reality, many tipped employees don’t claim all of their tips. But, that’s risky.
Legally, you are required to pay income taxes on your income, tipped or not. The IRS does have the right to review employer sales receipts in an audit. Employees could also be short-changing themselves in the long-run. Eligibility for Social Security and Medicare benefits are dependent on how much employees paid into those systems during their working career and also how much employers contribute.
Even though tips and mandatory service charges are not easy to keep track of, gratuity-based businesses must develop a system to be able to follow these types of income if they and their employees are to comply with the IRS ruling.
In general, restaurant employers should keep records of...
If you have any tip pooling agreements in place, voluntary or not, be sure to have them in writing and keep a copy signed by each participating employee. The documentation should include agreed upon rules and compliance. When tracking tips, be sure to include the shared tips appropriately for all employees tipped directly or indirectly through the tip pool.
Whether you are paying credit card tips out at the end of the day or each week in your payroll, be sure to keep records of all credit transactions and processing fees, especially if you are taking the fees out of your employees’ tips. Have employees sign for any tips you are paying out of the register at the end of the shift and record all tips in payroll for calculation and collection of taxes.
Implement a strategy for employees to record the amount of their tips every day they work. Some timekeeping systems will allow employees to record their tips when clocking out for each shift. Use a simple written log or the IRS provided forms - IRS Form 4070 or IRS Form 8027. Either way, make sure that documentation is available at every step of the way for both your employees’ protection and yours.
Employees that earn less than $20 in tips are not required to report their tips to their employer for that month. However, when the total tips are greater than $20, employees must report tips monthly. This is done by filing IRS Form 4070, Employee's Report of Tips to Employer, or a similar statement with their employer.
Employees who receive tips must:
If you are a food or beverage business where you meet all the requirements below, employees must file IRS Form 8027 instead of Form 4070:
The IRS requires large food establishments to estimate what the tip income for the restaurant should be for the year by multiplying gross income by 8%, a percentage deemed a fair weighted average of tipping percentages. Employers and/or employees can apply to the IRS for a lesser percentage, but it will never be reduced below 2%. If the tip income reported by the employees is less than the estimated amount, the employer must allocate the excess amount among the employees.
Note that some compliance regulations vary from state to state, including things like credit card processing fee deductions from tips. In states where permitted, an employer can generally deduct a processing percentage from the employee’s tip.
Tip pooling also varies in each state. Review local laws to ensure you are in compliance. The rules around tip pooling have been mired in litigation since 2011, when regulations came into effect that forbid tip pooling between employees who customarily receive tips and those who do not. In 2018, a new law rolled back those requirements. Tip pooling can now include non-tipped employees but the bill prohibits employers, managers, and supervisors from collecting tips made by employees.
We published a resource specifically for restaurant managers and employers. Download our Payroll for Restaurants Guide for a detailed (but simple) list of everything you and your employees should know and do when it comes to recording tips, filing taxes and staying compliant.
Very quickly, here’s an overview:
In the end, you want employees to be happy and to make sure you are staying compliant. Running a restaurant isn’t easy and getting dinged by the IRS or Department of Labor doesn’t help. Teach your staff their rights (and yours). Contact Complete Payroll to help minimize your tax burden while staying compliant.
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