A problem restaurant owners run into frequently is trying to get their employees to report their tips. Employees hesitate to report the full amount of their tips because tips are subject to FICA and income taxes. Restaurant owners aren’t thrilled with tips either—the employer has to pay FICA and other payroll taxes on tips.
All tipped employees who earn more than $20 per month (in other words, all tipped employees) are required to report their tips to their employers at least monthly. Practically speaking, restaurant owners cannot force employees to report all tip income. Some courts have held that the employer is only responsible for distributing IRS Form 4070 to tipped employees and instructing them to fill it out and return it. However, if the IRS performs a tip audit on the employer and finds unreported tips, the employer is responsible for the 7.65% employer portion of FICA. The employer will then have to amend federal and state payroll tax returns to report the additional tips. As a silver lining, the additional assessed FICA tax on tips qualifies for the Tip Tax Credit.
Restaurant’s Responsibility to Submit Annual Tip Income Report
Certain restaurants must report sales and tip information to the IRS annually on Form 8027. This form is required for restaurants that meet the following criteria:
- Tipping is customary—this generally includes most restaurants, but usually doesn’t include fast-food restaurants, cafeterias, and restaurants that assess a service charge greater than 10%
- Food or beverages are sold
- More than 10 employees are normally employed
The number of employees refers to all employees, not just tipped employees. More than 50% owners are not counted as employees. The number of employees is based on the average number of employees in two months—in the slowest month and in the busiest month of the year.
Restaurants that operate in multiple locations must file a separate tip tax return for each location—even if the multiple locations operate within the same corporation or LLC.
Even if there are 10 or fewer employees and the tip tax return is not required, employees must still report their tips.
There are a few things to note about this form:
- Gross sales are reduced by sales tax
- The form requests credit card sales, credit card tips, and total tips and total sales—based on this information the IRA can compare the tip percentage on credit sales and compare it to the tip percentage on cash sales. If credit card sales are tipped at 15% and cash sales are tipped at 3%, there is likely a problem.
- The form multiplies total sales by 8% and compares this amount to the total reported tips. If the 8% of sales is larger than reported tips, employers are required to increase reported tips and allocate the increased tips to tipped employees
It is important to keep track of sales that are not tipped such as carryout sales, sales to employees, sales from nonfood items such as T-shirts or posters, sales for which a service charge was added, and customer walkouts.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.