CARL WATTS & ASSOCIATES

October 26, 2015

www.carlwatts.com
office@carlwatts.com
Washington DC
 tel/fax 202 350-9002
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Tipping is widely practiced in the United States for a variety of services traditionally associated with receiving a tip or gratuity on top of the total bill.


Whether you are a tippable employee yourself or you have such employees working for you, you are already well aware that tips are considered income and must be reported as such.

The Department of Labour specifies that tipped employees are those who customarily and regularly receive more than $30 per month in tips. Tips are the property of the employee. The employer is prohibited from using an employee’s tips for any reason other than as a credit against its minimum wage obligation to the employee (“tip credit”) or in furtherance of a valid tip pool. Only tips actually received by the employee may be counted in determining whether the employee is a tipped employee and in applying the tip credit. The entire tip amount is treated as earned wages with the exception of months in which tip income was under $20.

Tips may include:

  • Cash tips received directly from customers.
  • Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
  • The value of any noncash tips, such as tickets, or other items of value.
  • Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangement.

Now let us see what responsibilities must be fulfilled by tipped employees and employers with such employees from the IRS point of view.

As an employee who receives tips, you must do three things:

1. Keep a daily tip record.


To do this you can use Form 4070A, Employee's Daily Record of Tips. In addition to the information asked for on Form 4070A, you also need to keep a record of the date and value of any noncash tips you get, such as tickets, passes, or other items of value. Although you do not report these tips to your employer, you must report them on your tax return.


2. Report tips to the employer, unless less than $20.

The Internal Revenue Code requires employees to report to their employer in a written statement, all cash tips received except for the tips from any month that do not total at least $20. Cash tips include tips received from customers, charged tips (e.g., credit and debit card charges) distributed to the employee by his or her employer, and tips received from other employees under any tip-sharing arrangement. No particular form must be used. The statement must be signed by the employee and must include:

  • Employee's name, address, and social security number,
  • Employer's name and address (establishment name if different),
  • Month or period the report covers, and
  • Total of tips received during the month or period.


You must report tips to the employer by the 10th of the month after the month the tips are received.

3. Report all tips on an individual income tax return.

You must use Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to report the amount of any unreported tip income to include as additional wages on your tax return and your share of social security and Medicare tax owed on those tips.

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.
Tax Requirements for
Income from Tips

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As an employer you have multiple obligations with regard to employee tip income, including record-keeping and reporting responsibilities, collecting taxes on tips, filing certain forms, and paying or depositing taxes.

Employers are required to retain employee tip reports, withhold employee income taxes and the employee share of social security and Medicare taxes based upon wages and tip income received, and then report this information to the IRS. In addition, employers are required to pay the employer share of social security and Medicare taxes based on the total wages paid to tipped employees as well as the reported tip income.

However, your obligation to withhold the employee's portion of FICA and income taxes is limited to the amount of employee funds under your control (e.g., the non-tip wages you would otherwise pay the employee). If insufficient funds are available, they should be applied to the taxes in the following order:

  • Taxes on the employee's regular wages,
  • Federal, state and local income taxes on the employee's regular wages,


  • Social security and Medicare taxes or railroad retirement taxes on the employee's reported tips, and
  • Federal, state and local income taxes on the employee's reported tips.

As an employer of a tipped employee you are only required to pay $2.13 an hour in direct wages if that amount plus the tips received equals at least the Federal minimum wage, the employee retains all tips, and the employee customarily and regularly receives more than $30 a month in tips. If an employee's tips combined with the employer's direct wages of at least $2.13 an hour do not equal the Federal minimum hourly wage, the employer must make up the difference.

If you are in the restaurants business, 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.

When the total reported to you is less than 8%, you must allocate the difference between the actual tip income reported and 8% of gross receipts. There are three methods for allocating tip income:

  1. Gross Receipt Method, which is a comparison of the business’s entire gross receipts compared to the gross receipts of each employee. (following a not too complicated formula). The employer calculates 8 percent of the business's gross receipts and figures out what each of the tipped employees, based on their sales, should have contributed to reach that 8 percent. For those employees who fall short, the employer takes the difference between what the employee's contribution should have been and what the employee actually reported and allocates it to the employee's W-2 form, making the employee responsible for that amount.

  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.


It is worth mentioning that special rules apply to employers who operate large food or beverage establishments.

If dealing with tax returns may seem easier for a tipped employee, as an employer you cannot afford not to enroll help and advice from a tax professional in all your dealings with the IRS.