How to Pay Tips or Gratuities in Payroll

Background

Patriot handles reported tips but not allocated tips. To read more about allocated tips, visit the IRS website.

When you have employees who receive tips, auto gratuities, or service charges you will need to report their tips in their payroll so that proper income tax can be withheld on those earnings.  For more information about paying tipped employees, see our blog article, “How to Handle a Tipped Employee’s Pay.”

Auto gratuities aren’t the same as tips.

• Tips are voluntary payments a customer chooses to leave for a service worker.
• Auto gratuities are charges the business adds (like a required service charge) and the customer doesn’t get to opt out.

Because the IRS treats tips and auto gratuities differently, they should also be set up differently in payroll. For more details, see our blog article “Tips vs. Auto Gratuities: What’s the Difference?”

The One Big Beautiful Bill Act lets employees in certain tipped positions claim a tax credit on their reported tips. The IRS outlines what counts as a tip and which jobs are considered tipped occupations. You will need to add the Treasury Tipped Occupation Code (TTOC) for tipped employees. See our help article, “How to Add Tipped Occupation Codes to Employees,” to learn how.

For more details, check out our blog post: “No Tax on Tips: How Payroll Is Affected,” for more information.

Auto Gratuity vs Tips W-2 Reporting

Note: “Yes, with limits” means deductibility under One Big Beautiful Bill subject to Treasury Code occupation classification (TTOC) and other applicable limits or reporting requirements.

How to Add Tips or Auto Gratuities (aka, Service Charges) to an Employee Pay

The money type you will use will depend on if the company has set the amount the customer has to pay or if it is a voluntary payment paid by the customer.

1. If you are paying an employee tips, you will need to select a TTOC (Treasury Tipped Occupation Code) for the employee located on their Pay Info record first for the One Big Beautiful Bill required reporting. Otherwise you will not be able to enter an amount in the Tips money type boxes. See our help article for more information, “How to Add Tipped Occupation Codes to Employees.”
   💡This is NOT required for auto gratuities or service charges because they are not a part of the One Big Beautiful Bill Tax Deduction on tips.
2. Go to Settings > Payroll Settings > Hours and Money Types > Money Types to see the pre-set Tip and AutoGratuity money types. You can mark these money types as “frequently used” on the Settings page so they always appear on step 1 of payroll.  Otherwise, you can toggle “Show All Hours/Money” at the top of step one in payroll.
   
   • Tips – Paid:  Use this Money Type if the employee has already been paid the tips or taken cash home at the end of their shift.
     • These tips will appear as taxable earnings, with Social Security Tips box 7 taxes reported on the employee’s W-2, and income tax deductions will be withheld. They will also have reporting for the tipped tax deduction on the W-2 with their designated TTOC and amounts allowed for the tip tax deduction.
     • These tips will not be included in their net pay, and will have taxes calculated on the amount you enter.
   • Tips – Owed:  Use this Money Type if the employee needs to be paid the tips (e.g., the tips were added to a credit card that the employee has not yet received).
     • Similar to “Tips – Already Paid,” these tips appear as taxable earnings, reported in Box 7 of the employee’s W-2, and income tax deductions will be withheld.  
     • These tips will be included (increase) employee net pay.
   • AutoGratuities – Paid: Use this money type if the employee has already been paid an auto gratuity (aka service charge) at the end of their shift.
     • This will not be included in the employee net pay, but will have taxes calculated in payroll.
     • These earnings will be reported in Box 1 (Taxable Wages), Box 3 (Social Security), and and local boxes, if applicable, on the employee W-2. These are NOT tips because they are not discretionary and will not be reported in the social security tips box 7.
     • Auto-Gratuities are not eligible for the One Big Beautiful Bill tip tax deduction.
   • AutoGratuities – Owed: Use auto gratuities (aka service charges) when you still need to pay the employee these monies.
     • This will be included (increase) in employee net pay.
     • Auto Gratuities appear as taxable earnings of the employee’s W-2 in box 1 (Taxable Wages) and Box 3 (Social Security), and local boxes, if applicable. These are NOT tips because they are not discretionary and will not be reported in the social security tips box 7.
     • Auto Gratuities are not eligible for the One Big Beautiful Bill tips tax deduction.
3. Go to Payroll > Payroll Tasks > Run A New Payroll.
4. If you have not marked the “Tips” or “AutoGratuities” money types as favorites you will need to toggle the “Show All hours/money” at the top of step one of payroll.
5. Enter the tip amounts, either in the appropriate box.
6. Continue to add hours and any other necessary earnings and continue to the next step of payroll.
7. Complete the rest of payroll as usual.

Note:  The employee’s gross wages must be greater than their reported tips so there is enough money to withhold taxes. If the amount of tips exceed gross wages, this will cause a negative net pay, and the payroll will not be processed.

[DEFINITION: Reported Tips]

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