Tips your employees receive from customers are generally subject to withholding. Employees are required to claim all tip income received. This includes tips you paid over to the employee for charge customers and tips the employee received directly from customers.
No report is required from an employee for months when tips are less than $20.
Tips paid in cash (or checks or other cash equivalent, including charged tips) of $20.00 or more, that an employee receives in a calendar month while working for any one employer, are wages subject to FICA, FUTA, and income tax withholding.
Once the amount of tips received in a calendar month reaches $20.00 from any one employer, the entire amount of tips received is included in wages, not just the amount over $20.00. An employee who receives $20.00 or more in tips must report those tips in writing to their employer by the tenth day following the month in which the tips are received.
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On the Tabs, mouse-over "Federal Q&A", "Miscellaneous Topics" and then click on "Taxes on Tip Income"
Employer Requirements
Employers must collect income tax, employee social security tax and employee Medicare tax on tips reported by employees. You can collect these taxes from an employee's wages or from other funds he or she makes available.
Allocation of Tips
As an employer, you must ensure that the total tip income reported to you during any pay period is, at a minimum, equal to 8% of your total receipts for that period.
In calculating 8% of total receipts, you do not include nonallocable receipts. Nonallocable receipts are defined as receipts for carry out sales and receipts with a service charge added of 10% or more.
When the total reported to you is less than 8%, you must allocate the difference between the actual tip income reported and 8% of gross receipts. There are three methods for allocating tip income:
- Gross Receipt Method
- Hours Worked Method
- Good Faith Agreement
Employers can request a lower rate (but not lower than 2%) for tip allocation purposes by submitting an application to the IRS. Detailed instructions for computing allocation of tips, reporting allocated tips to employees, and for requesting a lower rate can be found in the Instructions for Online Tax Return Form 8027. (PDF)
Note: The amount shown as allocated tip income is for information purposes only. You are not required to withhold Income or Social Security taxes on the allocated tip income. The amount of tip income allocated to each employee is shown in box 8 of their Online Tax Return Form W-2.
Tip Reporting Requirements for Employers
Employers who operate large food or beverage establishments must file Online Tax Return Form 8027 (PDF) to report employee tip income. A large food or beverage establishment is defined as business where all of the following apply:
- Food or beverage is provided for consumption on the premises
- Tipping is a customary practice
- More than 10 employees, who work more than 80 hours, were normally employed on a typical business day during the preceding calendar year.
A worksheet for determining whether a business meets the criteria listed above is included in the Instructions for Online Tax Return Form 8027. (PDF)
References/Related Topics
