Reporting Tips vs. Service Charges—Tips for EmployersJune 09, 2017
Attention employers, do you know the difference between tips and service charges? A payment must pass a “four factor test” to be considered a tip, and not a service charge. Read on.
Do you know the difference between tips and service charges? The IRS is reminding employers that automatic gratuities and any additional amount imposed on the customer by the employer are not tips but service charges. So, how exactly do you distinguish between the two? Read on.
What are tips?
Customers determine tips according to the service received by the employee. These payments are completely discretionary. They include:
- Cash tips received directly from customers
- Electronic tips made through credit card, debit card, gift card, or any other electronic payment method.
- The value of any noncash tips like tickets
- Tip pools/Tip sharing arrangements
And service charges?
These are payments required from the customer, including things like:
- Large dining party (automatic gratuity added if you have more than x number of people)
- Banquet event fee
- Cruise ship package fee
- Hotel room service charge
- Bottle service charge
The 4 factor Tip Test
It’s a tip if....
- The payment is made free from compulsion.
- The customer has the unrestricted right to determine the amount.
- The payment was not negotiated nor dictated by employer policy.
- The customer has the right to determine who the payment goes to (typically).
Service charges are reported as non-tip wages paid to the employee. Some employers retain part of the service charges, but only amounts distributed to employees are non-tip wages to those employees.
Reporting service charges- Employers who distribute service charges should (for tax withholding and filing requirements) report them as regular wages.
- Employees must report all cash tips received to their employer (excluding tips from any month that total less than $20). All cash and noncash tips should be included in an employee’s gross income and be subject to federal income taxes.
- Both directly and indirectly tipped employees must report tips to their employers
- Directly tipped employees- Any employee who receives tips directly from patrons (waiters, waitresses, bartenders and hairstylists)
- Indirectly tipped employees- Someone who does not normally receive tips directly from patrons (i.e. bussers, service bartenders, cooks and salon shampooers)
- Employers must do a few things....
- Retain employee tip reports
- Withhold income taxes
- Withhold employee share of social security and Medicare taxes on reported tips from wages or from other funds provided by the employee
- 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.
- Report income tax and social security and Medicare taxes withheld from employee wages (on form 941)
- Report the employer share of social security and Medicare taxes (on form 941)
- Deposit taxes in accordance with federal tax deposit requirements
Two more important distinctions to make between service charges and tips:
- Service charges paid to employees are not includible in the FICA Tip Credit calculation. Only tips are eligible for this beneficial employer tax credit.
- In many States, including RI, service charges are subject to sales tax and meals and beverage taxes. It’s important that your POS system is set up to include these charges in the taxable total.
Make sure you’re well-read in these special rules, employers. You do not want to be caught incorrectly reporting. Contact any member of our Hospitality Services Team for further guidance.