Payroll

Guide for Reporting Tip Income by Employers & Employees

MIKE D’AVOLIO, CPA, JD

SEPTEMBER 2, 2019

Employers and employees in the service industries that involve tipping need to comply with a unique set of tax rules.  Like wages, you must pay income tax, Social Security tax and Medicare tax on tip income. Tax professionals can share the following guide with clients and prospects to educate and encourage them to stay compliant with the rules.

Basics

In general, tips are discretionary payments made by customers to employees and can be paid in cash, credit cards, noncash (such as tickets) and through tip pools from other employees (indirect tips).  To qualify, the tip must be voluntary and the amount cannot be negotiated. 

On the other hand, service charges are required to be paid by the customer even if it’s called a tip or gratuity.  Examples of service charges include an automatic gratuity for a large dining party, a banquet event fee, a hotel room service charge and a bottle service charge.  In general, service charges are reported as non-tip wages paid to the employee, excluding the portion retained by the employer.

Reporting tip income

Employees must report all cash tips received to the employer, except total tips under $20 for a given month.  Employees need to report tips to the employer by the 10th of the month after the month the tips are received. Noncash tips received from customers are not reported to the employer.

All cash and noncash tips are required to be included in the employee’s gross income and are subject to tax.  Both direct tips and indirect tips (e.g. bussers and cooks) must be reported to the employer, but you can reduce the number of reportable tips you share with other employees.  For example, if you receive a $150 tip and give the bartender $25, you would only report $125.

Employer requirements:

  • Retain employee tip reports
  • Withhold income taxes and the employee’s share of FICA taxes
  • Pay employer’s share of FICA taxes
  • File Form 941, Employer’s Quarterly Federal Tax Return along with federal deposits
  • Include tip income on Form W-2, Box 1 (Wages, tips & other compensation), Box 5 (Medicare wages and tips) and Box 7 (Social Security tips)

Reporting service charges

Service charges that are distributed to an employee by an employer are treated the same as regular wages. Service charges are:

  • Not included in the employee’s daily tip record
  • Included on Form W-2, Boxes 1, 3 and 5
  • Subject to FICA taxes and income tax withholding

Allocated tips

If the total tips reported by all employees at a large food or beverage establishment (see below) are less than 8 percent of gross receipts, the employer is required to allocate the difference between 8 percent of gross receipts and the actual tip income among all employees who received tips.

If the employer allocates tips:

  • They are shown separately on Form W-2, Box 8 (Allocated tips)
  • They are not included in Boxes, 1, 5 or 7 (i.e. income tax and FICA is not withheld since the employee didn’t report the amount to the employer)
  • The employee includes the allocated tips in income and files Form 4137, Social Security and Medicare Tax on Unreported Tip income

Large food or beverage establishments

An employer who operates a large food or beverage establishment must file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.  The report includes receipts from food and beverages, tips reported by employees and allocated tips.

An establishment is considered a large food or beverage establishment if all of the following requirements are met:

  • The operation is located in the 50 states or D.C.
  • Food or beverages are provided for consumption on the premises, excluding fast food operations
  • Tipping employees for food or beverages by customers is customary
  • The employer normally employed more than 10 employees on a typical business day during the preceding calendar year

Employer’s share of Social Security & Medicare taxes on unreported tips

If an employee fails to report their tips to the employer, the employer is not liable for the employer’s share of Social Security and Medicare taxes (FICA) on the unreported tips until the IRS notifies and demands the taxes.  The employer is not liable to withhold and pay the employee’s share of Social Security and Medicare taxes on any unreported tip income.

Voluntary tip compliance agreements

The IRS has established voluntary tip compliance agreements for industries where tipping is customary, such as restaurants and bars.  Among the benefits, the agreements help the employer and employee understand and meet their tax obligations through education, instead of through enforcement and examination actions by the IRS.

Wrap-up

As discussed, the rules surrounding the proper reporting of tip income offer a few twists to reporting typical wages.  The bottom line is that tip income is taxed just like wages.  Be sure your employer and employee clients that work in the service industries remain compliant with these filing requirements.

IRS resources

It’s summertime…and these tips can help make livin’ easy for teens with jobs

With summer almost here, many students will turn their attention to making money from a summer job. Whether it’s flipping burgers or filing documents, the IRS wants student workers to know some facts about their summer jobs and taxes.

Not all the money they earn will make it to their pocket because employers must withhold taxes from their paycheck. Here are some tax tips young individuals should know when starting a summer job.

New employees:  Employees – including those who are students – normally have taxes withheld from their paychecks by their employer. When anyone gets a new job, they need to fill out a Form W-4, Employee’s Withholding Allowance Certificate. Employers use this form to calculate how much federal income tax to withhold from the new employee’s pay. The Withholding Calculator on IRS.gov can help a taxpayer fill out this form.
 
Self-employment: Students who do odd jobs over the summer to make extra cash are self-employed. This include jobs like baby-sitting or lawn care. Money earned from self-employment is taxable, and self-employed workers may be responsible for paying taxes directly to the IRS. One way they can do this is by making estimated tax payments during the year.
 
Tip income: Students working as waiters or camp counselors who earn tips as part of their summer income should know tip income is taxable. They should keep a daily log to accurately report tips. They must report cash tips to their employer for any month that totals $20 or more.

Payroll taxes: This tax pays for benefits under the Social Security system. While students may earn too little from their summer job to owe income tax, employers usually must still withhold Social Security and Medicare taxes from their pay. If a student is self-employed, Social Security and Medicare taxes may still be due and are generally paid by the student.

Reserve Officers’ Training Corps pay: If a student is in an ROTC program, and receives pay for activities such as summer advanced camp, it is taxable. Other allowances the student may receive – like food and lodging – may not be taxable. The Armed Forces’ Tax Guide on IRS.gov provides details.

Here’s what taxpayers should know about doing a Paycheck Checkup

Everyone should check their withholding by doing a Paycheck Checkup ASAP, even if they did one in 2018. The federal income tax is a pay-as-you-go tax. This means that taxpayers pay the tax as they earn or receive income during the year. This also means that taxpayers can avoid a surprise at tax time by checking their withholding amount the year before.

By checking their withholding, taxpayers can make sure enough is being taken out of their paychecks or other income to cover the tax owed. Here are some things taxpayers should know about withholding and why checking it is important:

  • An employer generally withholds income tax from their employee’s paycheck. The employers then pays it to the IRS on the taxpayer’s behalf.
  • Anyone who receives a pension or annuity should also check their withholding to make sure their withholding from their pension or annuity cover their taxes.
  • Wages paid, along with any amounts withheld, are reflected on the Form W-2, Wage and Tax Statement. Employees generally receive this statement at the beginning of the year before they must file their taxes.
  • The information an employee gives to their employer on Form W–4, Employee’s Withholding Allowance Certificate and income the employee earned determines withholdings. For the 2019 Form W-4 this includes:
    • Filing status: Either the single rate or the lower married rate.
    • Number of withholding allowances claimed: Each allowance claimed reduces the amount withheld.
    • Additional withholding: An employee can request an additional amount to be withheld from each paycheck.
  • When filling out a 2019 W-4, employees must specify a filing status and their number of withholding allowances. They cannot specify only a dollar amount of withholding.
  • Doing a Paycheck Checkup now is especially important for anyone with a 2018 tax bill.
  • By changing withholding now, employees can boost tax withholding early in 2019 to head off a potential tax bill a year from now. In addition, taxpayers should always check their withholding when a major life event occurs or when their income changes.
  • The best way for people to do a Paycheck Checkup is to use the Withholding Calculator on IRS.gov.

Done with taxes this year? Use 2018 return to get 2019 withholding right 


 

WASHINGTON — Millions of taxpayers filed a 2018 tax return in the last few weeks, making now a prime time for everyone to consider whether their tax situation came out as they expected. If it didn’t, they can use their recently finished 2018 return and the IRS Withholding Calculator to do a Paycheck Checkup and adjust their withholding.

Checking and then adjusting their tax withholding can help make sure they don’t owe more tax than they are expecting. Usually they can also avoid a surprise tax bill and possibly a penalty when they file next year. At the same time, with the average refund more than $2,700, some taxpayers may choose to reduce their withholding to have a larger paycheck and smaller refund.

Now is an ideal time to check withholding, since having a completed tax return is helpful when using the Withholding Calculator on IRS.gov. Since taxpayers need to estimate deductions, credits and other amounts for 2019, having similar information from the 2018 return can make using the Withholding Calculator easier.

Who should do a Paycheck Checkup?

Though doing a Paycheck Checkup is a good idea every year, for many people, it’s even more important this year. This includes anyone who:

  • Adjusted their withholding in 2018 – especially those who did so in the middle or later part of the year.
  • Owed additional tax when they filed their tax return this year.
  • Had a refund that was larger or smaller than expected.
  • Had life changes such as marriage, childbirth, adoption, buying a home or when income changes. 

In addition, most people are affected by changes made in the Tax Cuts and Jobs Act (TCJA), the tax reform legislation enacted in December 2017. These changes included lowered tax rates, increased standard deductions, suspension of personal exemptions, the increased Child Tax Credit and limited or discontinued deductions. As a result, the IRS continues to encourage people to check their withholding, even if they did a Paycheck Checkup in 2018.

This includes taxpayers who:

  • Have children and claim credits, such as the Child Tax Credit
  • Have older dependents, including children age 17 or older
  • Itemized deductions in the past
  • Are a two-income family
  • Have two or more jobs at the same time
  • Only work part of the year
  • Have high income or a complex tax return

Those with more complex situations may need to use Publication 505, Tax Withholding and Estimated Tax, instead of the Withholding Calculator. This includes employees who owe self-employment tax, the alternative minimum tax or tax on unearned income from dependents. It can also help those who receive non-wage income, such as dividends, capital gains, rents and royalties. The publication includes worksheets and examples to guide taxpayers through these special situations.

Sooner is better for a Paycheck Checkup

The IRS urges everyone to do a Paycheck Checkup as early in the year as possible so that if a tax withholding adjustment is needed, there is more time for withholding to happen evenly during the rest of the year. Waiting means there are fewer pay periods to withhold the necessary federal tax.

Changing withholding

Employees can use the results from the Withholding Calculator to see if they need to complete a new Form W-4, Employee’s Withholding Allowance Certificate, and submit it to their employer. In some instances, the calculator may recommend that the employee have an additional flat-dollar amount withheld each pay period. Taxpayers don’t need to send this form to the IRS after giving it to their employer.

Those who don’t pay taxes through withholding, or pay too little tax that way, may still use the Withholding Calculator to determine if they need to pay estimated tax to the IRS quarterly during the year. Those who are self-employed generally pay tax this way. See Form 1040-ES, Estimated Taxes for Individuals, for details.

More information:

IRS Withholding Calculator

The IRS encourages everyone to use the Withholding Calculator to perform a quick “paycheck checkup.”  This is even more important this year because of recent changes to the tax law for 2018.

The Calculator helps you identify your tax withholding to make sure you have the right amount of tax withheld from your paycheck at work.

There are several reasons to check your withholding:

  • Checking your withholding can help protect against having too little tax withheld and facing an unexpected tax bill or penalty at tax time next year.
  • At the same time, with the average refund topping $2,800, you may prefer to have less tax withheld up front and receive more in your paychecks.

If you are an employee, the Withholding Calculator helps you determine whether you need to give your employer a new Form W-4, Employee’s Withholding Allowance Certificate. You can use your results from the Calculator to help fill out the form and adjust your income tax withholding.

Plan Ahead: Tips For Using This Program

The Calculator will ask you to estimate values of your 2018 income, the number of children you will claim for the Child Tax Credit and Earned Income Tax Credit, and other items that will affect your 2018 taxes. This process will take a few minutes.

  • Gather your most recent pay stubs.
  • Have your most recent income tax return handy; a copy of your completed Form 1040 will help you estimate your 2018 income and other characteristics and speed the process.
  • Keep in mind that the Calculator’s results will only be as accurate as the information you provide.  If your circumstances change during the year, come back to this Calculator to make sure that your withholding is still correct.
  • The Withholding Calculator does not ask you to provide sensitive personally-identifiable information like your name, Social Security number, address or bank account numbers. The IRS does not save or record the information you enter on the Calculator.

IMPORTANT NOTE: This Withholding Calculator works for most taxpayers. People with more complex tax situations should use the instructions in Publication 505, Tax Withholding and Estimated Tax, expected to be updated in early spring. This includes taxpayers who owe self-employment tax, alternative minimum tax, the tax on unearned income of dependents or certain other taxes, and people with long-term capital gains or qualified dividends.

Ready to start? Make sure Javascript is enabled.

 

Withholding Calculator

To Change Your Withholding:

  • Use your results from this Calculator to help you complete a new Form W-4, Employee’s Withholding Allowance Certificate, and
  • Submit the completed Form to your employer as soon as possible. Withholding takes place throughout the year, so it’s better to take this step as soon as possible.

Special Note for 2019:  If you follow the recommendations at the end of this Calculator and change your withholding for 2018, the IRS reminds you to be sure to recheck your withholding at the start of 2019. This is especially important if you reduce your withholding sometime during 2018. A mid-year withholding change in 2018 may have a different full-year impact in 2019. So if you do not file a new Form W-4 for 2019, your withholding might be higher or lower than you intend. To help protect against having too little withheld in 2019, we encourage checking your withholding again early in 2019.

If you have additional questions about your withholding, consult your employer or tax advisor.

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