When preparing an employee's Form W-2, include wages, tips and other compensation in the box labeled "Wages, tips, other compensation". Include Medicare wages and tips, and social security tips in their respective boxes. When figuring the employers liability for federal unemployment tax, add the reported tips to the employee's wages.

As an employer, you must ensure that the total tip income reported to you during any pay period is, at a minimum, equal to 8% of your total receipts for that period.

In calculating 8% of total receipts, you do not include non-allocable receipts, which are defined as receipts for carry out sales and receipts with a service charge added of 10% or more.

2.

Hours Worked Method. If you employ fewer than the equivalent of 25 full-time employees, both tipped and non-tipped during a payroll period, you may use the hours-worked method to allocate tips. You are considered to have employed fewer than the equivalent of 25 full-time employees during a payroll period if the average number of employee hours worked per business day during a payroll period is less than 200 hours. The hours worked method is similar to the gross receipt method;

3.

Good Faith Agreement, which is a written agreement between the employer and at least two-thirds of the employees of each occupational category of employees who receive tips.

If you are an employee receiving tips, reporting them is not a very difficult matter, but as an employer with a restaurant or similar business, advise from a professional is always a wise investment.

Whether you’re an employer or an employee, there are a few things you should know about tips income and how to report it.

You must include in your gross income all cash tips you receive directly from customers, tips added to credit cards, and your share of any tips you receive under a tip–splitting arrangement with fellow employees.

As an employee, you must report tip income that is more than $20 on Form 4070 (Employee’s Report of Tips to Employer), or on a similar statement. This report is due on the 10th day of the month after the month the tips are received. The statement must be signed and include the following:

You have to report your tip income with your wages on Line 7 of Form 1040 or 1040A, or on Line 1 of Form 1040EZ. Your Form W-2 will include tips reported to your employer; however, if non-cash items were not included they must be added to your Form W-2 amounts.

Reporting accurate tip income may help you improve your financial standing so that you will have an easier time for acquiring a loan. It also can provide you with higher levels of Social Security, Medicare, worker's compensation and employee pension benefits. Excellent record-keeping habits will provide you with the most accurate information.

You must collect the employee's portion of the social security and Medicare taxes and the income taxes. You can collect these taxes from the employee's wages or from other funds the employee gives you up to the close of the calendar year. If you don't have enough money from the employee's wages and other funds, apply the amounts available in the following order:

You can withhold any remaining unpaid taxes from the employee's next paycheck. If you cannot collect all of the employee's social security and Medicare taxes on tips, show the uncollected amount in the appropriate box on the employee's Form W-2, Wage and Tax Statement. Also, show the uncollected amount as an adjustment on your employment tax return (e.g., Form 941, Employer's Quarterly Federal Tax Return). You may want to inform your tipped employees that if all the income taxes on their wages and tips are not collected by the end of the year, employees may be subject to a penalty for underpayment of estimated taxes.