Do you own a service industry small business, such as a restaurant, hair salon or hotel? Then it’s important as an employer that you understand your payroll responsibilities when it comes to calculating wages, employee reporting and tax requirements. One factor that affects your business’s payroll tax obligations is when your employees receive gratuities for their services. Do you know the rules?
According to the Internal Revenue Service, there are two types of gratuities – tips and service charges. As an employer, you need to make sure you know the difference between the two and how they are reported to the IRS.
What are tips?
A tip is an optional or extra payment made by a customer to an employee, directly or indirectly. A customer is not obligated to give the tip and has the right to determine how much he/she will give as a tip. The tip should not be negotiated nor can it be dictated by employer policy. Generally the customer has a right to determine who receives the gratuity. The absence of any of these factors indicates the gratuity may be a service charge.
Tips can be cash or electronic payments made with a credit card, debit card or gift card. Tips can also be made with non-cash items of value, such as tickets, passes or gifts. The value of the item determines the tip given. Additionally, employees may receive tips from other employees through formal or informal tip-sharing arrangements such as tip pools or tip splitting.
What are service charges?
As stated above, the absence of any of the factors that constitute a tip means the payment may be a service charge. Examples of common service charges include:
- Automatic gratuities for large dining parties.
- Banquet event fees.
- Cruise trip package fees.
- Hotel room service charges.
- Bottle service charges by nightclubs and restaurants.
IRS Reporting Requirements
The IRS has specific rules for reporting and taxing tips and service charges.
Employee/employer obligations concerning tips:
- Directly tipped employees (for example, wait staff, bartenders or hairstylists) and indirectly tipped employees (such as bussers, cooks or hostesses) must report to their employers all cash tips received each month. Tip totals less than $20 a month are excluded. Employees don’t have to report non-cash tips to their employers. However, all cash and non-cash tips should be included in the employee’s gross income and are subject to federal income taxes.
- Employers must keep records on employee tips so they can withhold payroll taxes, including income taxes, social security and Medicare taxes on the employee’s wages and tip income they have received.
- Employers must pay their share of social security and Medicare taxes based on the total wages they pay to tipped employees, in addition to the reported tip income.
Employee/employer obligations concerning service charges:
- Employers who distribute service charges to employees should treat this income as regular wages. Employers would follow normal payroll tax withholding and filing requirements.
- If the employer keeps a portion of all service charges, this income would be considered revenue for the business.
- Since service charges would be included in the employee’s gross income, the employee must report and pay income taxes on the amount.
How to handle tips and service charges can be complicated for small businesses when it comes to payroll taxes. The Payroll Department, a payroll services provider located in Brownsburg, IN, can help your business by handling all of your payroll processing, filing requirements and payments for you. Contact us today to learn more about our payroll services.
– Ariane of The Payroll Department Blog Team