As I mentioned in a blog I wrote last year, Are Your Employees Properly Reporting Tips?, the indeterminate nature of tips can make complying with the IRS a tough job for restaurant owners.

Many restaurants have, and are, experiencing difficulties with tip reporting, and though most of the responsibility rests on the employee to report his/her tips accurately, there is also some weight on employers to make sure this is done correctly.

The “problem” with tips

A good portion of restaurants across the country use a pay system in which tipped employees have a base pay that is far less than minimum wage, but make up for it through tips received from customers.

For purposes of this blog, let’s use RI as an example.

The minimum wage allowable in RI for those occupations earning tips is $3.39 per hour. As such, waiters, waitresses and bartenders can be paid that minimum rate and their pay is then “grossed up” under tips to ensure the minimum wage of $9.60 per hour is attained. In effect, the employers only pay them $3.39 per hour. However, if the tips reported by the employee do not get the employee to $9.60 per hour, the employer must cover the difference. Also, the employer must pay the employer match for the FICA taxes (social security and medicare) on the tip "wages" as well as the base pay wages.

The reality is that, for the most part, tipped employees typically make more than $9.60 per hour. Generally restaurants use a point of sale system and each waiter, waitress and bartender has their own code when entering sales receipts. If a ‘tip’ was placed on a credit card, it carries forward to payroll summaries and employers are able to see exactly how much in credit card tips that waiter or waitress really did earn.

But the amount tipped employees make in cash tips...well that still remains a mystery.

Who bears responsibility for tip reporting?

It is the employees’ responsibility to report their tips to the employer. BUT, it is also the employer’s job to educate and inform the employees of their responsibility to report 100% of their tips. The employer needs this information to include in the quarterly and annual payroll reports required to be reported to the state and IRS.

Reporting: Form 4070

The employees should be providing their employer a reporting of tip income for each payroll period (at least bi-weekly). The form of reporting can be done through a Form 4070 or any other format that provides the required information.

Can tips be entered through the Point-of-Sales System?

Entering tips through the POS system may suffice as a proper reporting method. The employer should be using the charged tips reported by the POS system + any cash tips reported by the employee as the number to add to payroll each pay period.

If an employee reports a lower amount of tips than what the POS system shows the employee received in charged tips, the employer should speak with the employee to understand the difference. For instance, if the employee "tipped out" some of their tips to bus staff or hosts, then the lower number may be accurate. By not asking and looking the other way, the employer is essentially submitting fraudulent information to the government. It is the employer’s job to receive a “tip reporting” from each employee for every payroll period so that the information can be added to each employee’s wages. That tip income will be included in employees' W-2s at the end of the year.

Risks at hand

If the IRS comes knocking, they will hold the employer liable for the employer’s portion of the FICA taxes on unreported tips, provided the IRS can substantiate the unreported tip income. If the POS system used in the restaurant tracks all charged tips by employee, it won’t be very difficult for them to substantiate some amount of unreported tip income.

And they can assess that tax on the employer even if they don’t go after the employee for under-reporting. Since turnover can be high in the restaurant industry, the IRS may take the easy road and just go after the employer. So, that’s 7.65% tax on the unreported tips plus interest and penalties. Consider that compounded for a few years, and the liability could be substantial.

Is it okay to simply “gross” the tips up to the $9.60 amount?

No! That means you, the employer, decided what amount the employees reported for tip income. (Just enough to get the employee to minimum wage…) You don't want to be in that position.

Pay out charged tips each night or include in weekly paycheck instead?

More and more restaurants are paying out the charged tips with the weekly paycheck. Why?

• As more customers pay with credit cards, many times there is not enough cash at the end of the night to pay all the tips out. To ensure there is enough cash each day, managers or owners must go to the bank to pull out cash, sometimes daily, to have enough to cover the tips to be paid out.
• Tip income is subject to the employee's share of FICA taxes. If tip income is significant, it's possible the base pay alone will not be sufficient to cover the FICA taxes on the tipped income. You could be in a position where the employee owes the company for the shortage. By holding onto the tips and paying them out with payroll, you are guaranteed to have enough funds to withhold the proper amount for taxes. So, you don’t have to chase down employees to collect any shortage.
• When the employees take their charged tips daily, they are getting cash before the employer has even received the funds from the credit card company. So the employer is, in effect, fronting the cash to pay the tips and waiting a few days to get “paid back” by the credit card companies. If funds are tight, this can exacerbate a cash flow problem.

Drawbacks?

Additional FICA taxes- Employers can sometimes view full tip reporting as adding cost to them and therefore are more willing to accept the under-reporting. By withholding the charged tips and paying out with payroll, a more accurate amount of tips is reported. This does create additional FICA taxes owed by the employer. HOWEVER, the employer gets to claim a tip credit when it files the income tax return, which essentially reimburses the employer for FICA taxes paid on tip income in excess of minimum wage. So it may cost money up front, but the cost of the taxes paid on tips in excess of the minimum will be “refunded” in the form of lowering the income tax liability at the end of the year.

As you can see, and probably already know as a restaurant owner, tip reporting is difficult because of the ambiguity involved in how much employees are actually making. If you need assistance with reporting to the IRS, or have any questions about your existing tip reporting methods, contact a member of our Hospitality Services Group today.