Payroll tax is particularly complicated for restaurants because employees often receive multiple types of compensation. Tips, salaries, minimum wage, hourly — these are all treated separately by the IRS, making legal compliance a challenge. What’s more, recordkeeping can be complicated. Here’s a brief overview of payroll and compensation issues common to the restaurant industry.
1. Tax on tips
The IRS requires employers to collect taxes on tips reported by staff. Employees must report their tip income accurately and honestly and submit it to employers. The employer then receives the same federal and state taxes they would from ordinary income, as well as social security, Medicare, and unemployment tax.
While all tips are income and must be reported, not all tips are the same:
When tips are received in cash, accounting is more difficult. Cash is more challenging to track, and employers have no control over the accuracy of reporting. Employees who don’t report their tip income accurately can incur penalties. Worse, the restaurant can be subject to a tax audit.
Credit and debit cards
While convenient for customers, credit card tips are a headache for restaurants. Managers must ensure that tips are paid out to employees in the right amounts. This process adds a layer of complexity to accounting, tracking payroll, and other financial tasks.
Tips that are divided among employees are treated the same as other tips and must be reported to the IRS, even if they are received indirectly. For example, if a waiter earns a tip and shares it with a hostess, the hostess must report it as income, whether the tip was received directly or not.
Tip pooling has benefits for restaurant owners. When there is income disparity between positions, it can level the playing field. For example, a restaurant’s host staff is typically paid minimum wage. By participating in the tip pool, they can make as much as wait staff and bartenders. Restaurants can attract talented new hires and offer an extra incentive for your best employees to stay in the position. That said, there are pros and cons to tip pooling and it may not be suitable for all restaurants.
For large groups such as parties and banquets, restaurants may add an extra charge to the bill. The IRS calls these automatic gratuities and considers them revenue for the restaurant, not the servers. Employers have the discretion to share these gratuities with employees. In that case, employees should treat them the same as regular wages for tax withholding and filing requirements.
What’s the difference between a tip and a service charge?
The IRS defines tips as:
- Cash received directly from customers
- Extra money from customers through electronic payment, including credit cards, debit cards, and gift cards
- The value of any non-cash gifts-in-kind, such as tickets
- Amounts received from tip pools or tip splitting
Examples of service charges include:
- Automatic gratuities (usually 18 percent or more) attached to large dining parties
- Banquet event fees
- Cruise-trip package fees
- Hotel room service charges
- Bottle service charges at nightclubs and restaurants
While employees are responsible for accurately and honestly reporting tips, the employer is responsible for meeting all other aspects of federal requirements.
2. Tip credit
Restaurant owners can reduce their labor costs through tip credit.
The Fair Labor Standards Act (FLSA) defines tipped employees as any worker who regularly receives more than $30 per month in tips above their base pay. If an employee’s tips combined with the cash wage do not equal the minimum hourly wage, the employer must make up the difference.
The FLSA helps employers close this gap by giving them a credit that goes towards their minimum wage obligation. Employers pay a minimum cash wage for tipped employees of $2.13/hour. The difference between minimum wage and the cash wage is the tip credit. Currently, the maximum tip credit is $5.12. This can save the restaurant a significant amount in direct wages and federal income tax liability.
Here’s an example of how tip credit works:
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 earnings up to the minimum wage, or the employer must make up the difference.
The bottom line? A tip credit can help employers save hundreds of dollars each year per employee.
3. Minimum wage and overtime
While the federal minimum wage has remained consistent since 2009, many states and municipalities have elected to adopt a higher minimum wage rate. For non-tipped hourly employees, the federal minimum wage is $7.25 an hour. However, if the federal, state or local minimum wage amounts differ, employees must be paid the higher rate. In most situations, employees must be paid one-and-a-half times their regular rate of pay for any time that exceeds 40 hours in a work week.
Since tipping income varies and is self-reported by employees, payroll for hourly workers may seem easier to control. However, working overtime is common in the restaurant business, and the number of hours can vary from paycheck to paycheck.
To[RMK1] manage payroll efficiently, employers need to carefully account for overtime hours via punch cards or other time-tracking methods. An automated time and attendance solution can be integrated with payroll and other HR processes to save time, reduce errors, and cut down on paperwork. Employees can also “punch in” and track their time with an easy-to-use mobile app.
For tipped employees: Overtime is calculated on the full minimum wage, not the lower direct (or cash) wage payment. The employer may still take a tip credit on overtime hours.
- For salaried employees: Overtime payment for a non-exempt salaried employee will be dependent on how the salary is defined and what hours are included in the payment. Generally, for salaried employees, you divide the total pay in a workweek by the number of hours worked.
- For non-tipped hourly employees: If an hourly employee works more than 40 hours in a single week, any hours over 40 are paid at one-and-a-half times the employee's regular rate of pay.
4. Meals as fringe benefits
Many restaurants provide meals to employees on the premises. This is especially common with kitchen staff who don’t leave the job to take their meals.
The IRS says you can exclude the value of meals from the employee's wages if they meet the following tests:
- They are furnished on your business premises.
- They are furnished for your convenience.
If you allow your employee to choose to receive additional pay instead of meals, then the meals aren’t excluded. The exclusion also doesn't apply to cash allowances for meals.
However, you can generally exclude the value of “de minimis” benefits from an employee’s wages. These are of so little value, accounting for them would be considered unreasonable or administratively impractical, for example coffee, doughnuts, or an occasional meal taken by an employee working overtime.
The IRS has complex criteria for meals and other benefits. To learn more, see "Meals on Your Business Premises."
5. Reporting tips
The U.S. Department of Labor classifies tipped employees as those who receive more than $30 per month in tips.
While the responsibility for honestly and accurately reporting all tips (both credit card and cash) falls to the employee, the employer is responsible for meeting all other aspects of the federal reporting requirements. These include but are not limited to:
- Educating and training all employees on proper reporting methods for tips
- Gathering tip reports from each employee at least once per month
- Paying FICA and state income taxes on employee tipped income
- Filing IRS Form 8027 if your restaurant regularly accepts tips and employs more than 10 workers
- Applying for the FICA Tip Tax Credit on IRS Form 8846 if desired
- Ensuring that tip reporting for all employees meets the federal minimum threshold of 8 percent of gross receipts
- Verifying the accuracy of the reports with any employee who does not meet the minimum threshold and applying for a special exception with the IRS
Call in the experts
Many restaurant owners seek professional assistance to help them solve their payroll challenges. By partnering with a reputable payroll company, you can simplify administrative processes, stay in compliance, and get all the tax benefits due to your business.
Better yet, your day-to-day operations can be more streamlined and efficient, so you can focus on growing your business. The right payroll service can offer innovative solutions, such as how to handle tips made with credit cards or better ways for employees to track their time.
For tips on how to simplify your tax issues, download our guide, "Run your Restaurant without Running Ragged."