A Guide to Restaurant Payroll Challenges
Restaurant payroll is governed by complex laws for employee wages and tips. Restaurants pay several forms of wages with varying tax treatments, making legal compliance a challenge. For example, a restaurant employee's paycheck may include regular wages, tips and gratuities, banquet tips, service charges, and meals — with the Internal Revenue Service (IRS) requiring employers to handle each of these categories in a particular way. Let’s look at a few payroll issues restaurant owners should be familiar with.
Tax on Tips
The IRS requires employers to collect taxes on tips reported by staff. Specifically, employers must collect federal income tax; social security and Medicare taxes; federal unemployment tax; state and local income taxes; and state unemployment tax. These taxes can be collected from employees' wages or from other funds they make available.
The Tax Equity and Fiscal Responsibility Act (TEFRA) and Tip Reporting and Alternative Commitment (TRAC) legislation governs taxable tip income. As of 2013, the IRS considers automatic gratuities — usually tips of 18 percent or more added to the bills of large parties or banquets — to be revenue for the restaurant rather than tips for the servers. Thus, sales tax applies to these earnings. The IRS treats service charges added to customers' bills and distributed among employees as wages.
Restaurant employees are also required to report all tip income. The IRS requires that the total tip income reported during any pay period equals at least 8 percent of the total receipts for that period. Restaurant owners can allocate tip income in one of three ways: using gross receipts, hours worked, or a good-faith agreement with employees.
The FICA Tip Credit
Restaurant owners may be able to reduce labor costs by applying the Federal Insurance Contribution Act (FICA) tip credit toward the minimum wage of staff earning $30 or more per month in tips. Owners can apply what their workers earn in tips toward their minimum wage obligation equal to the difference between the required cash wage (which must be at least $2.13) and the federal minimum wage. Thus, a server who earns generous tips can save the restaurant a significant amount in direct wages and federal income tax liability. (Note that when using the tip credit, restaurant owners must calculate overtime based on the full minimum wage, not the lower direct wage, and cannot take a larger tip credit for an overtime hour than for a straight time hour.)
Currently, the maximum tip credit an employer can claim under the Fair Labor Standards Act (FLSA) is $5.12 per hour — the federal minimum wage of $7.25 minus the minimum required cash wage of $2.13. (If the restaurant is in a state that mandates a higher minimum wage, employees must be paid the higher minimum.) Here's an example of how a server's tips contribute to the employer's requirement to pay at least the federal minimum wage:
The server, paid at the minimum wage of $7.25 an hour, works 40 hours a week.
$7.25 x 40 = $290.00
The server's required cash wages multiplied by the hours worked equals their direct wages.
$2.13 x 40 = $85.20
The minimum wage required by the FLSA minus direct wages equals tips to the minimum wage.
$290.00 - $85.20 = $204.80
In this example, the server needs $204.80 in weekly tips to bring their earnings up to the minimum wage, or the employer must make up the difference.
While on the job, many restaurant workers eat meals prepared by their employers. The IRS regards this practice as a fringe benefit. Owners can exclude the value of meals provided to employees from their wages — making the meals nontaxable — if:
- Provided meals are on business premises; and
- The meals were for the convenience of the employer (i.e., employees didn't have to leave their jobs to find a meal).
Calling In the Experts
Many restaurant owners seek professional assistance navigating the complexity of restaurant payroll. By partnering with a reputable payroll company, they can get help with paying employees promptly and accurately, complying with restaurant payroll tax requirements, and getting all the tax benefits due to their business.