Tip Reporting For Restaurants: How To Track & Report Employee Tips for the IRS

One of the many responsibilities restaurant managers have is tracking and reporting the income, including tips, received by tipped employees. It's technically up to the employee to track and report any gratuity income received over $20 each month. But as the employer, you also have many responsibilities when it comes to reporting employee tips to the IRS and withholding the correct amount of payroll taxes. Please note this article only addresses IRS impacts, but employers should consult with an HR Professional or legal counsel to also review compliance with applicable wage and hour laws when paying tipped employees.

Here are steps restaurant managers can take when it comes to tracking employee tips.

1. Set a Company Policy

Establishing a company policy regarding tip reporting is an essential practice for any employer who wants to avoid the negative consequences that can occur if tips are improperly handled. With a compliant policy in place, employers can accurately track tips, record them in their own records, and avoid potential legal issues with the IRS. Such a policy should outline the expectations for all employees, including the tips they must report, and which records they are responsible for maintaining. In addition, a written policy should be distributed to tipped employees as well.

Having a clear policy in place is especially important when restaurants use a tip pool in which tips are disbursed among multiple employees. The policy should outline not only what employees should report, but also when tips are pooled, who is responsible for sharing them, what portions of tips may be received from the tip pool, and how the tip pool affects what must be reported for tax purposes. By explicitly outlining the responsibilities for both employer and employees, clear expectations will be set from the beginning of employment, leading to better recordkeeping and helping to avoid employee frustrations surrounding tipping policies.

2. Use Tip Tracking Apps or Software

Tip tracker apps and other similar software have proven to be effective tools in monitoring and reporting tips. These tools help both employees and employers to accurately track tips, thus reducing the risk of errors and discrepancies. Employees can easily record their tips through these apps, and employers can access the data in real-time. This feature can help to ensure that employees get paid on time by reducing the likelihood of an underpayment or delayed payment of tips.

Using tracking apps can also help to reduce paperwork and save time. Employees no longer have to spend extra time tracking tips manually, and employers can have aggregated tips automatically calculated for each employee on a periodic basis that corresponds with the pay cycle. Server tip tracker apps also help employers monitor the performance of their staff in handling tips, providing data that can inform decisions on areas that need improvement. By using tracking software effectively, restaurant managers can streamline the entire tip tracking process and improve overall operations. With Paychex, Paychex Flex offers integration’s with industry-leading tip tracking software to better serve you and your employees.

3. Collect a Tip Report From Employees Every Pay Period

It's not the restaurant manager's job to keep track of all the tip money collected by every employee on every shift. For instance, there's no way a manager can know exactly how much of a cash tip was left by every customer.

But the employer must require employees to report their tip income every pay period — and it's in their best interest to train those employees to accurately report their tips. That's because if your employee makes more than $20 in tips per month, you are responsible to withhold income, Social Security, and Medicare taxes on reported tips. You are also required to pay the employer's portion of FICA and FUTA taxes on those tips.

There are various ways to collect regular tip reports from employees, and the IRS offers Form 4070A, Employee's Daily Record of Tips as an option for recording tip income daily. However, use of that form is not mandatory, and the IRS will accept alternatives as long as the employer is collecting the same information. Technologies such as the Netspend Tip Network^TM can make tip income reporting easier.

Please note that some jurisdictions require that employers collect tip information on a more frequent basis (e.g., daily), so the above pay period information may not apply to you.

4. Withhold the Right Amount From Employees' Paychecks

Once you know how much tip income each employee received for a given pay period, you must report this information to the IRS along with the number of hours each tipped employee worked and their hourly wage.

You will need to calculate the correct amount of payroll taxes that must be withheld from each employee based on their hourly wage and reported tip income. If you outsource your payroll, the provider you work with can help you make these calculations. This information will also be included on the restaurant's quarterly tax return (Form 941). The annual W-2 that employees receive must include their reported tip income as well.

5. File the Annual IRS Tip Reporting Form — Form 8027

If tipping is customary in your establishment and more than 10 people are regularly employed, you must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, every year. This document summarizes the restaurant's total sales for the year, charged sales, charged tips, and total reported tips.

One way the IRS uses this report is to identify restaurants that may have unreported tip income. The IRS requires that the total tip income reported during any pay period equals at least 8% of the total receipts for that period. If your reported tips are less than this, you must allocate additional tip income to the W-2 of every tipped employee who reported less than 8% of their respective sales so that their total reported income reflects a minimum 8% allocation.

Restaurant owners can allocate tip income in one of three ways: using gross receipts, hours worked, or a good-faith agreement with employees. The IRS offers a detailed explanation for each of these three methods.

The Risks of Not Reporting Cash Tips

Tip reporting accuracy is crucial for both employers and employees to ensure compliance with applicable tax laws. For employers, one of the negative consequences of inaccurate tip reporting is being subjected to IRS audits. The IRS tends to scrutinize businesses that do not report their tips accurately, and in cases of noncompliance, they may face massive fines and penalties.

For employees, not reporting cash tips may result in losing out on potential benefits. Other aspects of an employee's payroll — such as Social Security earnings, benefits eligibility, or retirement savings — are based upon the reported value of earnings. When an employee reports fewer earnings, it could negatively impact future eligibility for these benefits or cause them to be ineligible altogether. Additionally, employees may face fines or penalties if inaccurately reported tips are found to be an intentional act on the part of the employee. Consequently, it's crucial for both employers and employees to maintain accurate and transparent tip reporting practices to reduce facing repercussions in the long run.

Is There a Penalty for Not Reporting Tips?

Failing to accurately report employees' tips can result in severe penalties for an employer. The IRS holds employers responsible for ensuring that reported tips are accurate and backed by proper documentation. If the employer does not report tips correctly, it may lead to a range of penalties, including fines, back taxes, interest, and even criminal charges in some cases.

Litigation associated with allegations of employer tip reporting fraud can also result in damage to the company's reputation and lead to loss of business. Once a basis for inaccurate tip reporting is found, former employees may also be more likely to come forward with additional complaints or lawsuits against the employer, causing additional financial burden. Therefore, it is essential for employers to stay informed on IRS tip reporting regulations, train their employees accordingly, and maintain precise records of all tips received. Doing so may prevent potential penalties and maintain a good relationship with both employees and the IRS.

Accurate Tip Tracking and Reporting Can Help Both Employees and Employers

It's in your best interest to make sure you're carefully tracking and reporting tip income received by employees at your establishment. Consider using a payroll service for your restaurant that can help with tracking employee tips and filing the correct reports with the IRS when required.