Tax Tip for Restaurant Owners: Track Tips

Given the multitude of issues restaurant owners and operators deal with on a daily basis, it’s easy to understand how small matters can slip through the cracks. But sometimes, seemingly small matters become big problems.

One area of potential oversight involves tracking employee tips. Though it may seem an insignificant task, failure to track tips properly can lead to an audit by the Internal Revenue Service (IRS) and damaging penalties, as the IRS has been cracking down on tip under-reporting in recent years.

The IRS recently published guidelines for reporting tip income that can help you avoid problems associated with under-reported tips.

Reporting Tip Income: It’s On You

The tips customers leave for your staff are generally subject to withholding. This means restaurant owners must be certain employees are claiming all their tip income. This includes tips you pass along to employees from customers paying and tipping with credit cards as well as the cash tips they receive directly from customers.

Employee Requirements: It’s On Them

Employees must report tip income on Form 4070, Employee's Report of Tips to Employer, or a similar statement. The report is due on the 10th day of the month following the month the tips are received. The statement must be signed by the employee and must including the following:

  • Employee's name, address, and social security number
  • Employer’s name and address
  • Month or period the report covers
  • Total tips received

Forms 4070 and 4070-A, Employee's Daily Record of Tips, are included in Publication 1244, Employee's Daily Record of Tips and Report to Employer. A report is not required for any month an employee’s tips are less than $20.

Collecting Tip-Related Taxes

Employers must collect income tax, employee Social Security tax and employee Medicare tax on any tips reported by their employees. These can be deducted from an employee's wages or collected in another way that might work better for you and your employees.

Tips as a Portion of Receipts

It is up to an employer to ensure the total tip income reported during any pay period is, at a minimum, equal to 8 percent of the total receipts for that period. This is also known as allocated tip income. In calculating 8 percent of total receipts, you are not required to include non-allocable receipts, which are receipts for items such as carryout sales and items with a service charge of 10 percent or more.

When the total tips reported to an employer amount to less than 8 percent, you are responsible for determining the difference between the actual tip income reported and 8 percent of gross receipts.

There are three methods for allocating tip income:

  • Gross Receipt Method
  • Hours Worked Method
  • Good Faith Agreement

Employers can request a lower tip allocation rate (though not lower than 2 percent) by submitting a request to the IRS. Detailed instructions for computing allocation of tips, reporting allocated tips to employees, and requesting a lower rate can be found in the Instructions for Form 8027. (The amount shown as allocated tip income is for information purposes only. You are not required to withhold Income or Social Security taxes on the allocated tip income. The amount of tip income allocated to each employee is shown in box 8 on their Form W-2.)

Big Restaurants = Big Tip Allocations

Employers who operate large food or beverage establishments must file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips to report employee tip income. A large food or beverage establishment is defined as a business where all of the following apply:

  • Food or beverage is provided for consumption on the premises
  • Tipping is a customary practice
  • More than 10 employees, who work more than 80 hours per month, were normally employed on a typical business day during the preceding calendar year.

A worksheet for determining whether a business meets the definition is included in the Instructions for Form 8027.

If you have questions about how to maximize tip-reporting procedures for your restaurant business, contact Michelle Roseberry at mroseberry@hbkcpa.com

For more details on official IRS rules for Restaurant Tip Reporting, visit the IRS website.

About the Author

Michelle Roseberry is the Principal-in-Charge of the Columbus, Ohio offices of HBK CPAs & Consultants and has been with the firm since 2015.

Michelle has extensive experience in audit and accounting services in both public accounting and private companies. She works with individuals and small to mid-sized business owners from a wide variety of industries such as: construction, employee benefit plans, restaurant/hospitality, manufacturing, and non-profit entities.

Michelle specializes in Construction Accounting and holds the related Certified Industry Technician designation. She also specializes in Audits of Qualified Employee Benefit Plans, including experience with many ESOP companies, and is Yellow Book certified to perform A-133 Single audits.

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