As the deadline for tax season quickly approaches, now is the time to take stock of the year that’s just past, get organized, and examine ways to improve upon your current systems and practices for the year ahead. Preparing for tax season for restaurants involves several key components to ensure compliance with tax regulations. One such factor for both restaurants and employees is tip reporting.
Tips play a huge role in the payment of restaurant employees, especially servers, bartenders, and delivery drivers. Therefore it’s critical for employers and employees alike to understand the rules surrounding reporting this income to the IRS.
As part of a restaurant service workers’ gross income, tips and gratuities are considered taxable income. They are viewed as compensation for a provided service even though the revenue does not come directly from the employer.
Generally, taxed at the same rate as regular earnings, employees and employers are responsible for reporting their tips and gratuities on their annual tax income returns.
Tip Reporting Responsibilities of Employees
Employees and employers each have specific reporting requirements that they must be aware of. According to the IRS, “all cash and non-cash tips received by an employee are income and are subject to Federal income taxes.” We’ve put together a list of the IRS requirements and how they may impact your restaurant.
According to the U.S. Department of Labor, a tipped employee is defined as “any individual who engages in a job in which they regularly receive more than $30 a month in tips.” State and local jurisdictions may also have their own definitions.
Tips are considered discretionary payments provided to employees by customers, often in cash or via an electronic payment method such as a credit card. Tips received from a tip pool or tip-sharing arrangements also qualify.
Tips can also include non-cash payments in the form of other items of value such as concert tickets or gift cards. While non-cash tips do not need to be reported to the employer, they must be reported on the employee’s tax return.
According to the IRS, federal standards require tipped employees to do the following:
1. Keep a daily record of all cash (including credit and debit card tips and tips through pools) and non-cash tips. Cash tips can be recorded by using Form 4070, Employee’s Daily Record of Tips.
2. The Internal Revenue Code requires employees to report all cash tips of $20 or more to their employer in a written statement by the 10th day of the following month. Tips received in February 2023, for example, must be reported to the employer by March 10, 2023. In a month when the 10th of the month falls on a weekend or legal holiday, the employee may provide the report to their employer by the next business day.
There is no particular form that needs to be used, but the statement must include the following:
Employee’s signature
Employee’s name, address, and social security number
Employer’s name and address
Month or period the report covers
Total of tips received during the month or period
3. Tipped income must be reported on the employee’s personal income tax return. When filing individual income taxes, an employee will use Form 1040. Employees must report the amount of any unreported tip income as additional wages.
Tipped employees may use the following tools to keep track of their daily tip record:
A handwritten paper report that contains the following:
Employee’s legal name
Address
Social security number
Workplace
Time period covered
Total amount of tips
Food Delivery Drivers
The gig economy has brought about an entirely new sector of food service workers. Whether a delivery driver is an employee of a restaurant or an independent contractor delivering for a third party platform, the tips they receive as gratuities from customers are considered taxable income.
Though their income is often received through a digital platform like an app or website, because food delivery drivers are taxpayers, they must must report income on their tax return, even if the income is:
From part-time, temporary or side work.
Paid in any form, including cash, property, goods or digital assets
Not reported on an information return form like a Form 1099-K, 1099-MISC, W-2 or other income statement.
Like servers in a restaurant, delivery drivers’ tips are optional cash or noncash payments customers make to employees.
Cash tips: Cash tips include those received directly from customers, electronically paid tips distributed by their employer or an app, and tips received from other employees under tip-sharing arrangements.
Non-cash tips: Non-cash tips are those of value received in any medium other than cash, such as: concert tickets, passes or other goods or commodities. Though these employees don't report non-cash tips to their employer, they must report the value of them on a tax return.
Reporting: Any cash tips the driver has not reported to the employer must be reported separately on Form 4137, Social Security and Medicare Tax on Unreported Tip Income, and included as additional wages on their tax return. The employee must also pay their share of Social Security and Medicare tax owed on those tips.
Point of Sale Systems’ (POS) Tip Reporting
With many POS systems, any tips added at the time of payment using a credit or debit card will be logged by the restaurant’s POS system. This provides both the management and employees with accurate totals.
Using restaurant POS software that integrates with tip reporting software can help automate the tip tracking and reporting process.
Reporting Responsibilities of Restaurants
Restaurants with tipped employees must also document that they are complying with labor and tax laws. This means that employers are obligated to pay tipped employees the correct amount and account for the appropriate amount of payroll taxes.
Tip Credit
A tip credit is a method that allows employers to credit a portion of employee tips as part of the hourly minimum wage. As of March 2023, under the Federal Fair Labor Standards Act (FLSA), an employer can claim up to $5.12 per hour as a tip credit. This is calculated by subtracting the $2.13 minimum cash wage from the $7.25 per hour federal (combined cash and tip) minimum wage rate.
In the case of overtime, this calculation repeats itself by factoring in the federal overtime minimum wage ($10.88 per hour) minus $5.12 per hour tip credit = $5.76/hr overtime minimum cash wage.
Many states and local jurisdictions have their own minimum wage and overtime laws with higher maximum and minimum wages that employers are required to follow, therefore it is critical to educate yourself on the state regulations where your restaurant operates.
To take advantage of the tip credit, an employer must make the employee aware of how the tip credit works and what the minimum and maximum wages will be. Employees can be informed during the onboarding process and by way of printed documentation, such as posters.
Payroll and payroll taxes
Hours worked, rate of pay, and tax rates all come together as a part of the restaurant payroll process. While the rate of pay is determined by state and federal minimum wage laws, the total amount paid is subject to payroll taxes, also known as employment taxes.
A payroll tax is a wage-related tax paid by a business to the Internal Revenue Service when distributing pay to employees. This includes income tax withholdings, unemployment tax, Medicare, and social security.
Income tax amounts are withheld and paid to the IRS by the employer. The employer withholds the employee’s portion of the owed FICA (Medicare and social security) taxes, contributes the employer’s portion of the owed FICA amounts, and remits unemployment taxes.
Because payroll taxes vary from state to state, it’s important to consult with an accountant or The IRS directly for the most accurate information.
Enforcing Tip Reporting
Currently, it is the employee’s responsibility to report their tips to the employer. All the employer is required to do is administer the payroll taxes once the tips are reported. Employees may be held liable by the IRS for unreported or underreported tips or other income.
Employers can be audited for not reporting tips. If the IRS suspects that an employer has failed in their tip reporting duties, the response by the IRS normally begins with a series of warnings followed by an audit. If it is found that an employer has intentionally misreported tipped income, this could result in serious fines and other repercussions.
More Tips to Keep in Mind
Service charges: Service charges, such as a percentage added onto a check for a large party, are not considered tips. Employers must classify service charges as non-tipped wages and employees should not report them as tips. Non-tipped wages are still taxable, however, and subject to payroll taxes.
Tip property: Tips are the property of the employee unless the tips are in a pool, which becomes the shared property of the employees participating in the pool.
Tip fees: Under current FLSA guidelines, employers may charge employees a small fee of up to 3% on tips received through a credit card payment in an effort to recoup the costs of the service charges. This fee can only be applied if it does not lower the employee’s rate of pay below the minimum wage.
DISCLAIMER: This content is provided for informational purposes only and is not intended as legal, accounting, tax, or other professional advice.
By Eileen Strauss
