IRS Tip Reporting for Restaurants: How To Track & Report Employee Tips

One of the many responsibilities restaurant managers have is tracking and reporting the income, including tips, received by tipped employees. Tips are the extra money customers leave because your staff did a great job. These include cash handed directly to servers, electronic tips processed through your POS system, and pooled tips shared among staff.

It's technically up to the employee to track and report any gratuity income received over $20 each month. But as the employer, you also have many responsibilities for IRS tip reporting and withholding the correct amount of payroll taxes.

In July, the 2025 tax law introduced a “No Tax on Tips” provision that impacts the restaurant industry. The provision is an individual deduction for the employee when filing personal tax returns, but employers maintain their payroll tax compliance requirements of withholding and reporting.

Please note this article only addresses the IRS impacts. Employers should consult with an HR Professional or legal counsel to review compliance with applicable wage and hour laws when paying all employees, whether they're tipped FOH staff or back of house workers.

Here are steps you can take as a restaurant manager when it comes to tracking employee tips and understanding how to report tips on taxes.

Employee vs. Employer Tip Reporting Responsibilities

IRS tip reporting requires shared responsibilities between employees and employers. Employees must keep daily tip records and report tips totaling $20 or more per month to their employer. They must also report all tips on their individual income tax returns.

Regarding how an employer must report tips to the IRS, it starts with an employer collecting employee tip reports. They must then withhold federal income taxes and Social Security and Medicare taxes from wages and reported tip income, pay the employer's portion of restaurant payroll taxes, and use the appropriate IRS and employee W-2 forms for reporting tips on taxes.

The IRS has released some guidance, as well as new forms, to facilitate the process, including a new Schedule 1-A form for employees who can use it to claim several deductions in 2025. The IRS also announced it will change W-2 and 1099 forms for 2026 tax filing.

The process of reporting hasn’t changed but there will be nuances employers must be aware of to help with their compliance obligations. Based on the proposed guidance from the IRS, employers will need to distinguish between tips based on additional factors, such as whether they are voluntarily or involuntarily given.

How To Manage Tip Reporting

During busy Friday night rushes, the last thing servers want to think about is paperwork. But proper tip reporting saves you from IRS headaches later. Here are restaurant payroll tips to help you manage.

1. Set a Company Policy

Establishing a company policy regarding tip reporting is essential for avoiding negative consequences from improperly handled tips. A compliant policy enables employers to accurately track and record tips while avoiding potential issues with the IRS. Such a policy should clearly outline employee expectations, including which tips must be reported and what records employees are responsible for maintaining.

If you're pooling tips among servers, bartenders, and bussers, spell out exactly how the tip pools work. Your policy should specify what employees must report, how pooled tips are shared, who manages the distribution, and how tip pooling affects tax reporting requirements. By defining responsibilities up front for both employers and employees, you improve record-keeping while reducing employee confusion about tipping procedures.

2. Use Tip Tracking Apps or Software

Most POS systems track credit card tips automatically, but you still need to figure out how to report cash tips. Tip tracker apps and similar software let servers easily record their tips, reducing errors and discrepancies. Using tracking apps can also help to reduce paperwork and save time. Employees no longer have to spend extra time tracking tips manually. These applications do the math for you, and you get clean numbers for payroll.

Server tip tracker apps also provide valuable performance data, helping employers identify areas for improvement in tip handling processes. Restaurant managers can streamline their entire tip tracking workflow and enhance overall operations through tracking software. Paychex offers integrations with industry-leading tip tracking software to better serve you and your employees.

3. Collect a Tip Report From Employees Every Pay Period

It's not the restaurant manager's job to keep track of all tip money collected by every employee on every shift — there's no way a manager can know exactly how much cash tip each customer leaves. However, employers must require employees to report their tip income every pay period and train those employees to accurately report their tips.

When employees make more than $20 in tips per month, you're responsible for withholding income, Social Security, and Medicare taxes on reported tips. You're also required to pay the employer's portion of FICA and FUTA taxes on those tips. The IRS offers Form 4070A, Employee's Daily Record of Tips, for recording daily tip income, though this form isn't mandatory. The IRS will accept alternatives as long as you're collecting the same required information. Technologies such as the Netspend Tip NetworkTM can make tip income reporting easier.

Please note that some jurisdictions require more frequent tip information collection (e.g., daily), so the pay period information above may not apply to you.

Required Information for Tip Reports

Tip reporting requires employees to include specific details in their monthly tip reports to maintain IRS compliance. The information also helps employers figure out how to calculate taxes on tips for employees.

Required information the employee must include:

• Legal name
• Current address
• Social Security number
• Workplace name and address
• Time period covered
• Total amount of tips received
• Employee signature

Employees who collect $20 or more in tips for the month must submit this report by the 10th day of the month following the reporting period. For example, January tips should be reported by February 10th.

4. Withhold the Right Amount From Employees' Paychecks

Once you know how much tip income each employee received for a given pay period, you must report this information to the IRS along with the number of hours each tipped employee worked and their hourly wage.

Do employers pay payroll taxes on tips? Yes, you will need to calculate the correct amount of payroll taxes to withhold from each employee based on their hourly wage and reported tip income. If you outsource your payroll, the provider you work with can help you make these calculations. This information will also be included on the restaurant's quarterly tax return (Form 941) and the employees' annual form W-2.

5. File the Annual IRS Tip Reporting Form — Form 8027

Whether you run a coffee shop, sports bar, or fine dining restaurant, if tipping is customary in your establishment and you regularly employ more than 10 people, you must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, every year. This document summarizes the restaurant's total sales for the year, charged sales, charged tips, and total reported tips.

One way the IRS uses this report is to identify restaurants that may have unreported tip income. The IRS requires that the total tip income reported during any pay period equals at least 8% of the total receipts for that period. If your reported tips are less than this, you must allocate additional tip income to the W-2 of every tipped employee who reported less than 8% of their respective sales so that their total reported income reflects a minimum 8% allocation.

Restaurant owners can allocate tip income in one of three ways:

• Gross Receipts Method: This method allocates tips based on each employee's percentage of total sales. If your reported tips fall short of the 8% requirement, the shortfall is distributed proportionally based on individual sales volume compared to overall establishment receipts.
• Hours Worked Method: Available only to companies with fewer than 25 full-time employees, this approach distributes allocated tips based on hours worked during the pay period. Employees who work more hours receive proportionally larger allocations, making it straightforward but less precise since it doesn't account for actual sales during those hours.
• Good-Faith Agreement: This allows employers to establish a written agreement with employees that outlines a fair and reasonable tip allocation method. At least two-thirds of tipped employees must sign the agreement, and it must meet IRS requirements and demonstrate compliance with the 8% minimum reporting threshold.

Knowing how to tax tips properly requires understanding each method's requirements for IRS server tip reporting compliance. For further guidance, the IRS offers a detailed explanation of how you report tip income to the IRS using each of these three methods.

IRS Tip Compliance Agreements

The IRS offers voluntary tip compliance agreements that can help make IRS tip reporting more manageable for your restaurant.

• Tip Reporting Alternative Commitment (TRAC): Focuses on employee education around reporting and claiming tips on taxes — you commit to quarterly training sessions and establish monthly reporting procedures, but you don't have to mandate specific tip amounts.
• Tip Rate Determination Agreement (TRDA): Sets predetermined tip rates for different job positions, with at least 75% of your employees agreeing to report at or above these rates.

Both programs help you understand how to report tips to the IRS and how to calculate taxes on tips for employees while providing structure for compliance.

The Risks of Not Reporting Cash Tips

Proper tip reporting is crucial for both employers and employees to ensure compliance with applicable tax laws. For employers, one of the negative consequences of incorrect tip reporting is being subjected to IRS audits. The IRS tends to scrutinize businesses that do not report their tips correctly. In cases of noncompliance, employers may face massive fines and penalties.

For employees, failing to report cash tips may result in losing out on potential benefits. Other aspects of an employee's payroll — such as Social Security earnings, benefits eligibility, or retirement savings — are based on the reported value of earnings. When an employee reports fewer earnings, it could negatively impact future eligibility for these benefits. If the IRS catches intentional underreporting, employees may face fines or penalties. Complete and transparent tip reporting practices by employers and employees reduce the risk of facing repercussions in the long run.

Is There a Penalty for Not Reporting Tips?

The consequences for failing to accurately report employees' tips can be significant for employers. The IRS can impose fines, back taxes, and interest charges when tip reporting requirements aren't met. In severe cases involving intentional fraud, employers may even face criminal charges.

Litigation related to allegations of employer tip reporting fraud can damage a restaurant's reputation and result in lost revenue. Once a basis for inaccurate tip reporting is found, former employees may also be more likely to come forward with additional complaints or lawsuits, increasing your financial burden. To avoid these penalties, employers should stay current with IRS tip reporting regulations, train their employees accordingly, and maintain precise records of all reported tips. Proactive compliance helps prevent costly penalties and maintains good standing with both employees and the IRS.

Accurate Tip Tracking and Reporting Can Help Both Employees and Employers

It's in your best interest to make sure you're carefully tracking and reporting tip income received by employees at your establishment. Consider using a payroll service for your restaurant that can help with tracking employee tips and filing the correct reports with the IRS when required.