Topic Number 761 - Tips – Withholding and Reporting
Employees who receive cash tips of $20 or more in a calendar month while working for you, are required to report to you the total amount of tips they receive. The employees must give you written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month aren't required to report their tips to you but must report these amounts as income on their tax returns and pay taxes, if any.
Cash tips include tips received directly from customers, tips from other employees under any tip-sharing arrangement, and charged tips (for example, credit and debit card charges) that you distribute to the employee. Both directly and indirectly tipped employees must report tips received to their employer.
Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, won't constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to social security tax, Medicare tax and federal income tax withholding. In addition, the employer can't use these non-tip wages when computing the credit available to employers under section 45B of the Internal Revenue Code, because these amounts aren't tips. Common examples of service charges (sometimes called auto-gratuities) in service industries are:
- Large party charge (restaurant),
- Bottle service charge (restaurant and night-club),
- Room service charge (hotel and resort),
- Contracted luggage assistance charge (hotel and resort), and
- Mandated delivery charge (pizza or other retail deliveries).
Employees can use Form 4070A, Employee's Daily Record of Tips, to keep a daily record of their tips, and Form 4070, Employee's Report of Tips to Employer, to report their tips to you. Both forms are available in Publication 1244.pdf, Employee's Daily Record of Tips and Report to Employer. You may also provide other means for your employees to report tips to you, for example, a system for electronic tip reporting by employees.
When you receive the tip report from your employee, use it to figure the amount of social security, Medicare and income taxes to withhold for the pay period on both wages and reported tips. You're responsible for paying the employer's portion of the social security and Medicare taxes.
Additional Medicare Tax applies to an individual's Medicare wages that exceed a threshold amount based on the taxpayer's filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual's wages paid in excess of $200,000 in a calendar year, without regard to filing status. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. There's no employer match for Additional Medicare Tax. For more information, see Questions and Answers for the Additional Medicare Tax.
You collect the employee's portion of these taxes from the wages you pay your employee, or from funds the employee gives you. If you don't have enough money from the employee's wages and funds your employee gives you, withhold taxes in the following order:
- Social security and Medicare taxes on the employee's wages,
- Federal income taxes on the employee's wages,
- State and local taxes imposed on the employee's wages,
- Social security and Medicare taxes on the employee's reported tips, and
- Federal income taxes on the employee's reported tips.
For purposes of these ordering rules, the rules for withholding an employee's share of Medicare tax on tips also apply to withholding Additional Medicare Tax on tips.
Withhold any remaining unpaid federal income taxes from the employee's next paycheck, up to the close of the calendar year. However, if you can't collect all of the employee's social security and Medicare taxes on tips by the 10th day of the month following the month in which your employee reported the tips, you don't have to collect the taxes. Show the uncollected amount as an adjustment on your employment tax return (for example, Form 941.pdf, Employer's QUARTERLY Federal Tax Return). Also, be sure to report the uncollected social security and Medicare taxes in the appropriate box on the employee's Form W-2.pdf, Wage and Tax Statement, but don't show any uncollected Additional Medicare Tax on Form W-2. You may want to inform your tipped employees that if all the federal income taxes and Additional Medicare Tax on their wages and tips won't be collected by the end of the year, they may need to make estimated tax payments. If an employee doesn't pay enough tax throughout the year, either through withholding or by making estimated tax payments, the employees may be subject to a penalty for underpayment of estimated taxes. Refer your employees to Publication 505, Tax Withholding and Estimated Tax, for additional information.
When preparing an employee's Form W-2, include wages, tips, and other compensation in the box labeled "Wages, tips, other compensation." Include Medicare wages and tips, and social security tips in their respective boxes. When figuring the employer's liability for federal unemployment tax, add the reported tips to the employee's wages.
If you operate a large food or beverage establishment, you must file Form 8027.pdf, Employer's Annual Information Return of Tip Income and Allocated Tips, for each calendar year, and may be required to allocate tips to your employees. You operate a large food or beverage establishment if tipping is customary, you provide food or beverages for consumption on the premises, and you normally employ more than ten people who collectively work more than 80 hours on a typical business day. If you have more than one large food or beverage establishment, you must file a separate Form 8027 for each establishment. Form 8027 is due on the last day of February of the next year (March 31 if filing electronically). If you meet the criteria for filing Form 8027 but don't file, the law provides for penalties for each failure to timely file a correct information return, including failure to file electronically, if required.
If the total tips reported by all employees at your large food or beverage establishment are less than 8 percent of your gross receipts (or a lower rate approved by the IRS), you must allocate the difference between the actual tip income reported and 8 percent of gross receipts among the employees who received tips. You may base the allocation on each employee's share of gross receipts or share of total hours worked, or on a written agreement between you and your employees. You're required to report the amount allocated on Form W-2 in the box labeled "Allocated Tips" for each employee to whom you allocated tips. Penalties may be imposed for both failing to file and failing to furnish a correct Form W-2 for each form on which you fail to include this required information. Don't withhold income, social security or Medicare taxes on allocated tips, since your employee didn't report these amounts to you.
Whether or not you're required to allocate tips, your employees must continue to report all tips to you, and you must use the amounts they report to figure payroll taxes.
Tip Rate Determination and Education Program
Employers may participate in the Tip Rate Determination and Education Program. The program primarily consists of voluntary tip compliance agreements developed to improve tip income reporting by helping taxpayers to understand and meet their tip reporting responsibilities. These voluntary tip compliance agreements offer many benefits for the employer and the employee. Two of the agreements are the Tip Rate Determination Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). An agreement, the Gaming Industry Tip Compliance Agreement (GITCA), is available for the Gaming (casino) industry. For more information about GITCA, TRDA, or TRAC agreements, search for Market Segment Understandings (MSU) by using keyword "MSU tips" on IRS.gov.
For more information on employer responsibilities, refer to Publication 15, (Circular E), Employer's Tax Guide. For more information on employee responsibilities, refer to Publication 531, Reporting Tip Income, Is My Tip Income Taxable?, and Reporting Tip Income - The Jill and Jason Show. Revenue Ruling 2012-18 provides guidance for employers and employees in a question and answer format regarding social security and Medicare taxes imposed on tips, including information on the difference between tips and service charges, the reporting of the employer share of social security and Medicare taxes under section 3121(q), and the section 45B credit.