Tips account for a considerable portion of employee wages in service-based businesses, such as restaurants. But when employees earn tips, what happens to the tip income? Do employees tell you how much they earn in tips? Or, do employees take their tips home only for you never to hear about the tips again?
What are reported tips?
Employees can earn tips directly from customers, from customer credit card charges, or from tip pooling. If an employee earns tips totaling $20 or more in a month, you and the employee must both report the tips.
It is important for employees to report all their tips to you. Payroll taxes are due on tips. If employees do not report their tips, they still owe the taxes plus penalties.
Also, if employees do not have enough reported tips, you might have to allocate tips to your employees. This means you will have to give extra tips to your employees. You will handle allocated tips differently than regular reported tips. To learn more about allocated tips, read our article, “What Are Allocated Tips?”
How to Report Tips on Payroll
Reporting tips on payroll requires different steps for both the employer and the employee.
Employee reporting requirements
Employees must report their tips to you and on their income tax return.
If employees have questions about reporting tip income, they should reference IRS Publication 531.
Report tips to employer
If an employee earns tips totaling $20 or more in a month, they must report the tips to you by the tenth day of the next month. Employees can report their tips to you with Form 4070 (also found in Publication 1244).
For example, Sarah earns $500 in tips during the month of May. She should record the tips she earns each day on Form 4070A. Sarah must report the tips to her employer by June 10. She can use Form 4070 to report her month’s tips to her employer.
You can require employees to report their tips to you more frequently, such as every week.
Report tips on income tax return
Employees must report their tips on their annual income tax return. If an employee did not report their tips to you, they should use Form 4137 to calculate their owed Social Security and Medicare taxes.
Employer reporting requirements
Once employees report their tips to you, you must withhold taxes and report the tips to the IRS.
All reported tips are taxable. You must collect payroll taxes on reported tips, including income tax, Social Security tax, and Medicare tax.
You must report each employees’ reported tips in box 1 of their Form W-2. Your employees will then use that information to fill out their tax return.
File Form 8027
If you run a large food or beverage establishment, you are required to file Form 8027.
You run a large food or beverage establishment if:
- Your business is located in the 50 states or the District of Columbia.
- It is customary for customers to tip employees.
- You employed more than 10 employees on a typical business day during the previous year.
On Form 8027, you will report the total tips employees reported for the year. You will also report any tips that you allocated to employees.
With Patriot’s simple payroll software, you can add tips to each employee’s paycheck. Try the software for free!
This article was originally published on 10/10/2014.