Have Employees Who Receive Tips? Here Are the Tax Implications
- Learn the definition of “tips.”
- Find out the difference between cash and noncash tips.
- Discover information about daily tips records.
- Learn how to report gratuities to employers.
- Discover employers’ requirements regarding tips.
- Learn about the tip tax credit.
Many businesses in certain industries employ individuals who receive tips (or gratuities) as part of their compensation. These businesses include restaurants, hotels, and salons.
How to define tips
Tips are optional payments that customers make to employees who perform services. They can be cash or noncash. Cash tips include those received directly from customers, electronically paid tips distributed to employees by employers, as well as tips received from other employees under tip-sharing arrangements. Generally, workers must report cash gratuities to their employers. Noncash tips are items of value other than cash. They may include tickets, passes, or other things that customers give employees. Workers don’t have to report these to employers but are subject to reporting the fair market value of the property as income on their individual return.
For tax purposes, four factors determine whether a payment qualifies as a gratuity:
- The customer voluntarily makes the payment,
- The customer has the unrestricted right to determine the amount,
- The payment isn’t negotiated with, or dictated by, employer policy, and
- The customer generally has the right to determine who receives the payment.
Gratuities can also be direct or indirect. A direct tip occurs when an employee receives it directly from a customer, even as part of a tip pool. Directly tipped employees include wait staff, bartenders, and hairstylists. An indirect tip occurs when an employee who usually doesn’t receive gratuities receives one. Indirectly tipped employees include bussers, service bartenders, cooks as well as salon shampooers, among others.
Daily tips records
Tipped workers must keep daily records of the cash gratuities they receive. To keep track of them, they can use Form 4070A, Employee’s Daily Record of Tips. It is found in IRS Publication 1244.
Workers should also keep records of the dates and value of noncash tips. Although the IRS doesn’t require workers to report these to employers, they must report them on their tax returns.
Reporting to employers
Employees must report gratuities to employers by the 10th of the month following the month they were received. The IRS doesn’t require workers to use a particular form to report them. However, a worker’s tip report generally should include:
- The employee’s name, address, Social Security number, and signature,
- The employer’s name and address,
- The month or period covered, and
- Total tips received during the period.
Note: Employees whose monthly gratuities are less than $20 don’t need to report them to their employers but must include them as income on their tax returns.
Employer requirements
Employers should send each employee a Form W-2 that includes reported tips. Employers also must:
- Keep their employees’ tip reports.
- Withhold taxes, including income taxes and the employee’s share of Social Security tax and Medicare tax, based on employees’ wages and reported gratuity income.
- Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees and reported tip income.
- Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
- Deposit withheld taxes in accordance with federal tax deposit requirements.
In addition, “large” food or beverage establishments must file an annual report disclosing receipts and gratuities on Form 8027, Employer’s Annual Information Return of Tip Income, and Allocated Tips.
Tip tax credit
If you’re an employer with tipped workers providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare taxes that you pay on employees’ tip income. The tip tax credit may be valuable to you. Have questions about the tax implications of gratuities? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.
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