Here are four basic ‘tips’ industry professionals need to know:
- The Tip Tax Credit. You can receive a tax credit on your income tax return related to the tip income reported by your employees. Your employees are required to report to you all of the tips they receive. In turn, you are paying the employer portion of FICA and Medicare tax, typically 7.65%, on the employees’ tip income just as you do on their ordinary wages (more on that below). On your Federal income tax return, you can claim an income tax credit for the employer portion of FICA and Medicare tax you pay on employees’ tip income. To give the tax credit perspective, if the total weekly tip income of your employee’s averages $3,000, your tip credit is almost $12,000.
- Employees Need to Report Tips to You Every Payroll Period. The IRS requires tipped employees to provide a monthly report of their tips, but you need this information for each payroll period to properly report. The IRS created Form 4070A, Employee’s Daily Record of Tips, to be used for this purpose but the information can be collected in any manner so long as the required basic data is captured. Most POS systems have a tip reporting function that can be utilized. Practically speaking, you have no way to force accurate reporting by your employees. However, you should still be diligent and have a clear policy for your employees. Note that should the IRS catch an employee under-reporting, you will be liable for the employer’s share of FICA tax on that amount.
- Report and Withhold Taxes on Tips. You are required to report tip income similar to ordinary wages for employee tax withholding. You also need to pay the employer’s share of payroll taxes, such as FICA and Medicare, on employee’s tip income.
- Annually Report Tip Information. You are required to file IRS Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, each year. If you have an entity with more than one establishment, you need to file a Form 8027 for each establishment as well as Form 8027-T. Be aware that the layout of Form 8027 is such that an overall tip rate of less than 8% on your total food and beverage sales is very obvious to the IRS. Based on industry norms, this would act as a honing beacon for the IRS that your employees may be under-reporting their tip income. In addition, if your tip rate is under 8%, you may need to allocate additional tip income to each tipped employee whose individual tip rate was under 8%.
As you may have already began to imagine, there are additional considerations that come into play as you attempt to comply with these items. For example, is your accounting or POS system set up to track sales by employee? If not, and you have to allocate additional tip income at year-end because your tip rate is under 8%, how can you determine which employees are reporting under 8%? And perhaps more concerning, how can you track individual employee tip reporting in real-time and protect yourself from systemic under-reporting that exposes you to liability?
The IRS has also established two programs whereby they will not bill you for FICA taxes on under-reported tips without first examining your employees to determine if they actually under-reported. In exchange, you (the eating or drinking establishment) agree to assume greater responsibility for getting employees to fully report their tips. If you are eligible, there are two programs:
- Tip Reporting Alternative Commitment (TRAC). This is an IRS drafted agreement that lays out the various responsibilities and commitments.
- Employer Tip Reporting Alternative Commitment (EmTRAC). The employer designs their own TRAC program that complies with IRS rules. EmTRAC is available if your employees receive both cash and charged tips, and it provides you some latitude in designing the tip procedures and the employee educational program.
The bottom line is that the restaurant and bar industry has several unique tax and accounting considerations. As such, it is important to work with CPAs, accountants and tax advisors that are focused on this industry and know and understand these rules.