How Restaurants Must Keep Track of Tipped Employees' Income for IRS Reporting
Among the many responsibilities restaurant managers have is tracking and reporting the tip income received by tipped employees. It's technically up to the employee to track and report any tip income over $20 each month. But as the employer, you also have many responsibilities when it comes to reporting tip income to the IRS and withholding the correct amount of payroll taxes.
Here are three key steps restaurant managers can take when it comes to tracking and reporting income from tipped employees:
1. Collect a tip report from employees every pay period.
It's not the restaurant manager's job to keep track of all the tip money collected by every employee on every shift. For instance, there's no way a manager can know exactly how much of a cash tip was left by every customer.
But the employer must require employees to report their tip income every pay period — and it's in their best interest to compel those employees to honestly report their tips. That’s because if your employee makes more than $20 in tips per month, you are responsible to withhold income, Social Security, and Medicare taxes on reported tips. You are also required to pay the employer’s portion of FICA and FUTA taxes on the tips.
There are various ways to collect regular tip reports from employees, and the IRS offers Form 4070A, Employee's Daily Record of Tips as an option for recording tip income daily. However, use of that form is not mandatory and the IRS will accept alternatives as long as the employee is collecting the same information. Some new technologies such as the Netspend Tip NetworkTM can make the tip income tracking easier.
2. 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.
You will need to calculate the correct amount of payroll taxes that must be withheld 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). The annual W-2 that employees receive must include their reported tip income as well.
3. File an annual IRS Form 8027
If tipping is customary in your establishment and more than 10 people are regularly employed, 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 percent 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 percent of their respective sales so that their total reported income reflects a minimum 8 percent allocation.
Restaurant owners can allocate tip income in one of three ways: using gross receipts, hours worked, or a good-faith agreement with employees. The IRS offers a detailed explanation for each of these three methods.
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 that can help with tracking and reporting tip income, along with filing the correct reports with the IRS.