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, 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 and Their 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
| Type | Include in Net Pay | W-2 Reporting | Tax Deductible Under OB3 |
|---|---|---|---|
| AutoGratuity – Owed | Yes | Box 1, 3, 5; state and local boxes, if applicable | No |
| AutoGratuity – Paid | No, earnings included and taxable wages are increased | Box 1, 3, 5; state and local boxes, if applicable | No |
| Tips – Owed | Yes | Box 1, 5, 7, 12 code TP; state and local boxes, if applicable | *Yes, with limits |
| Tips – Paid | No, earnings included and taxable wages are increased | Box 1, 5, 7, 12 code TP; state and local boxes, if applicable | *Yes, with limits |
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 Gratuities to an Employee Pay
There are two kinds of tips that you can use when paying your employees’ reported tips.
- Go to Settings > Payroll Settings > Hours and Money Types > Money Types to see the pre-set Tip and Auto-Gratuity 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 – Already Paid: Use this Money Type if the employee has already been paid the tips.
- These tips will appear as taxable earnings, reported in Box 7 (Social Security Tips) of the employee’s W-2, and income tax deductions will be withheld.
- These tips will not be included in their net pay, but will only 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.
- Auto Gratuities – Already 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 be taxed in payroll.
- These earnings will be reported in Box 1 (Taxable Wages) and Box 3 (Social Security) on the employee W-2.
- Auto-Gratuities are not eligible for the One Big Beautiful Bill tip tax deduction.
- Auto-Gratuities – Owed: Use auto-gratuities (aka service charges) when you still need to pay the employee these monies.
- This 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). 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.
- Tips – Already Paid: Use this Money Type if the employee has already been paid the tips.
- Go to Payroll > Payroll Tasks > Run A New Payroll.
- If you have not marked the Tips or Auto-Gratuities money types as favorites you will need to toggle the “Show All hours/money” at the top of step one of payroll.
- Enter the tip amounts, either in the appropriate box.
- Continue to add hours and any other necessary earnings and continue to the next step of payroll.
- 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.
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