Tip Reporting Basics

Tip reporting for businesses has become an extremely complicated area of law.  The business rules involve not only numerous areas of taxation but also employee reporting and wage and hour laws.  State and local governments also enforce their own separate laws involving a myriad of definitions and exceptions.

The rules are not business friendly; there are many traps and pitfalls even for well-intentioned.  We find that many business owners, their employees and the outside payroll services many times are all very challenged with reporting and tax compliance in this area.

There are now also specialized IRS audits occurring known as “Employment Audits” specifically designed to regulate these laws.  These audits are thorough and look at every detail of the law.

This brief article cannot begin to address all of the various aspects of the laws, but here are some basic rules in general that all business owners that have tipped employees should be aware of:

  1. All tips received by an employee of a business are owned by the employee and must be tracked and reported as income.
  2. Reporting of tip income includes tips for any type of reason for any type of business.
    Note: Business owners can be assessed for the tax on unreported tips.  The IRS will examine tip records that are known to the business (i.e. a credit card receipt with the tip amount included). The business then can and will be held liable for the tax on these tips.  The unfair aspect of this is that even though the business owners are liable they cannot force tipped employees to report all of their tips.  Employees must be educated on the laws and terminated if they still do not comply.  Any tax liability assessed against a business owner will usually become a personal liability of the owners if not paid by the business.
  3. Tips are paid voluntary from the customers to the employee.  Many restaurants include a mandatory service fee for large groups or other reasons.  If there are these involuntary service fees generated they are not tips but instead become the gross revenues of the business and are subject to any and taxes on gross receipts.  The payment of these amounts to employees is wages.
  4. The IRS is aware of this service fee issue and will start enforcement of this in their new audits.
  5. Wages paid by restaurants to servers below the federal minimum wage (“deemed tips”) is allowable in some states provided that the servers receive tips to make up the difference.
  6. Tip reporting issues can also involve many other aspects of a business – including concerns over workmen’s’ compensation insurance, tip pooling, credit card fees and withholdings on non-tipped wages.
  7. We advise any business owner who has tipped employees to gain at least basic understanding of these laws.  The alternative can be a very expensive surprise. 

Please contact a ShindelRock tax professional if you are a business owner that has concerns about how the tips at your company are being tracked and reported.