There has always been a level of confusion when it comes to employee tips/wages and the Internal Revenue Service. With the laws constantly changing, establishments must familiarize themselves with what is reportable as a tip and what is considered an employee wage. Not understanding these rules can lead to costly fines and penalties-and possibly a business shutdown in the event the business failed to recognize the potential tax implications.
Employee Tips versus Wages: What’s the Difference?
According to the IRS, tips are any additional gratuities paid to employees outside of their regular wages, while wages are a fixed hourly rate or salary amount that is paid on the company’s said pay dates as part of the employee’s gross income. The IRS considers wages taxable income, and employees who receive wages are required to pay income tax on it each year.
Tips, however, are grossly misunderstood by employees and employers alike. Some assume that tips are not taxable, especially if they’re not included on the employee’s usual paycheck. This is untrue. Cash tips that total over $20 for the calendar month are considered taxable by the IRS. Employees are required to report their cash tips in writing to employers at the end of the month, and this amount must be reported as income on an employee’s annual tax return. If, however, an employee receives less than $20 in cash tips, he or she isn’t required to report it.
Cash tips include, but are not limited to:
• Tips given directly to the employee by a customer
• Tips given directly to the employee from another employee (including tip-sharing situations)
• Employee tips added to a credit card charge as part of a customer’s bill
Tips May Not Always Be Tips
There are times when gratuities aren’t gratuities. According to a ruling made by the IRS in June of 2012, automatic gratuities–such as a percentage automatically added to the bill for a large party or automatic gratuity policy-are considered service charges, not employee tips. While this ruling passed in June of 2012, it won’t go into effect until January 1, 2014. This gives establishments time to learn the policies and adjust their in-house procedures so that they are in full compliance by next year.
When an establishment isn’t sure if employee tips are actually tips or service charges, it can look at the four factors that conclude a payment is a tip, not a service charge:
1. The payment is not compulsory.
2. The customer can determine the tip amount.
3. The tip amount isn’t required by the employer or dictated by the establishment, such as requiring a 20 percent tip due to a large party size.
4. The customer can decide which employee receives the tip.
Why It Matters
A lot of establishments don’t understand the repercussions of misunderstanding this new IRS ruling. Since service charges are not considered employee tips, they’re considered wages. Therefore, restaurants cannot include service charges on their FICA Tip Credit. In addition, employers who share portions of automatic gratuities must recalculate their employees’ hours and even overtime rates, since automatic service charges are considered wages for the employees and their gross income.
By reducing the amount of time it takes to calculate employee tips and wages you can focus more on what matters most: running your establishment. Now you can track employee tips easier and more accurately with TipCentral, a card-based tip management solution that helps businesses more effectively manage tips and tip-outs, simplify cash management, and maintain compliance.