Employees of some businesses receive tips as a part of their compensation. These businesses generally include restaurants, hotels, and salons.
Definition of Tips
Tips are optional payments paid by customers to employees who provide a service. Tips can be cash or noncash. Cash tips are payments paid to employees directly from customers, payments paid electronically and distributed by employers, and tips received from other employees as a part of tip-sharing programs. Typically, employees must report cash tips to their employers. Noncash tips are items with a value other than cash given to employees. Noncash tips may include tickets, passes, or other items given by customers. Noncash tips do not have to be reported to employers.
There are four factors that determine if a payment qualifies as a tip, these are used for tax purposes.
- Customer voluntarily makes the payment.
- Customer can determine the amount of the tip without restriction.
- Payment isn’t negotiated or enforced by employer policy.
- Customer generally has the right to determine who receives the payment.
Tips can be direct or indirect. A direct tip occurs when an employee receives the tip directly from a customer, even if included in a tip-sharing program. Employees who typically receive direct tips are wait staff, bartenders, and hairstylists. An indirect tip occurs when an employee receives a tip who normally wouldn’t. Employees who receive indirect tips include bussers, service bartenders, and cooks.
Daily Tip Records
Employees who receive tips must keep a record of the cash tips they receive daily. Employees can use form 4070A, Employee’s Daily Record of Tips, to keep a record of the tips received. This form is found in IRS Publication 1244.
Employees should keep a record of the noncash tips received, including the dates and value of these tips. The IRS doesn’t require them to be reported to employers, but they are required to be reported on the employees’ individual tax returns.
Reporting To Employers
All employees must report tips to their employer by the 10th of the month following the month the tips were received. The IRS doesn’t require these tips to be reported on a specific form, but this report should include:
- Employees name, address, Social Security number, and signature,
- Employer’s name and address,
- Month or period tips were received, and
- Total of tips received during month or period.
Note: Employees who receive less than $20 in monthly tips do not need to report them to their employer but are still required to include as income on their income tax returns.
Employers should send each employee a w-2 that includes reported tips. Employers also should:
- Keep employee tips reports.
- Withhold taxes based on employee’s wages and reported tip income, including income taxes and the employee’s share of Social Security tax and Medicare tax.
- Pay the employer share of Social Security and Medicare taxes based on total wages and reported tip income.
- Report all wage information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
- Deposit withheld taxes as required with federal tax deposit requirements.
Additionally, “large” food or beverage establishments are required to file an annual report disclosing receipts and tips on Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.
Tip Tax Credit
Businesses that provide food and beverages and employ tipped workers may qualify for a federal tax credit involving the Social Security and Medicare taxes that you pay on employees’ tip income. If you have questions on the tax implications of tips, please contact your Wegner CPAs advisor.