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Employee Tip Reporting for Service Industry Employers

Employees in the service industry get paid a federal minimum wage of $2.13 per hour. With this hourly wage, it’s no wonder why most servers primarily rely on customer tips to support themselves. 

Note that all tips (cash and non-cash) accepted by an employee are income bound by federal taxes. Employers usually have a unique tax and pay system that covers the income employees earn from tips. 

If you own a business where employees get tips, you must know how to track and report them. 

What Are Employee Tips?

Employee tips, also known as gratuity, are discretionary payments customers give to a particular employee for an excellent service. The customer determines the amount to tip to a service employee. 

However, the standard rule for tipping is giving at least 20% of the total bill. Most of the time, customers give optional payments directly to the service employees. Some business owners often use a tip pooling system, where all employees split the total amount of tips. 

And the guidelines for how these tips are divided rely on the employer. Often, tip pools include employees that seldom receive tips like bussers, cooks, dishwashers, and janitors. 

Do not confuse tips for service charges, though. Service charges are gratuity amounts added to a meal price. A discretionary payment is deemed a tip if:

  • The customer decides who gets the payment
  • The payment isn’t dictated or negotiated by the business owner
  • The customer decides the amount
  • The payment isn’t coerced or mandated 

Many customers look for travel packages on a budget for couples or individuals to enjoy the holidays. So employees must always be on their best behavior and provide excellent service to increase their chances of earning large tips this holiday season. 

When Should Employees Report Tips?

If the server earns at least $20 in tips within a month, they should record it and report it to the employer. Cash tips include debit or credit card discretionary payments given to a service employee, and customer tips are sometimes shared with other employees. 

On the other hand, non-cash tips include tickets, passes, and other commodities or goods. Employees who customarily and regularly earn tips of about $20 a month are called tipped employees. This term is used to distinguish between employees who are tipped and those who aren’t. 

All employees keep all of their collected tips. If the business accepts tips on debit or credit cards transactions, employers must pay the employee. But they can cut down the card transaction fee. 

Additionally, the Department of Labor says that this tip reduction shouldn’t bring down the employee’s pay to less than the federal minimum wage. If it happens, the employer must pay the employee on the next payday.

Employee Responsibilities

Tipped employees must do the following:

  • Keep track of their daily tip income. They can use an employee’s daily record of tips or Form 4070A
  • When the monthly tip income is at least $20, they must report it to the employer
  • They must report any unreported tip income on an individual income tax return

Employer Responsibilities

Employers have numerous obligations and liabilities when it comes to employee tip income. These include reporting and recordkeeping responsibilities, paying or depositing taxes, filing forms, and collecting taxes on tips. 

The employer must keep employee tip reports and is required to withhold taxes based on tip income and wages. On top of that, employers must pay the employer’s share of Medicare taxes and social security taxes based. 

These pieces of information must be included in the employee’s Form W-2. Also, the employer is required to file FUTA, Form 940, and Tax Return. Note that only the employer pays FUTA tax because it’s not withheld from the employees’ wages.

What Happens If The Employee Doesn’t Report Tip Income?

It’s the responsibility of the employee to report tip income to their employer for income tax purposes. Suppose the employee fails to report their tip income. In that case, the employer isn’t obligated for the employer’s share of Medicare taxes and social security tax on the unreported tip income until the IRS makes demand and notice for the taxes.

Moreover, employers aren’t required to withhold and pay the employee’s share of these taxes if they don’t report their tip income. 

Final Thoughts

The U.S. government considers anyone a tipped employee if they earn at least $30 per month in tips. The common professions that get tips include casino dealers, golf caddies, taxi drivers, hairstylists, bellhops, bartenders, and servers. While tipping is customary in the U.S., some countries practice tipping less frequently because employees are usually paid higher. 

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