Restaurants, salons, bars, hotels and delivery businesses all deal with tips. Tips are wages for tax purposes, and employers have specific duties for reporting and withholding on them. The IRS explains the rules in Publication 531 and Publication 15.

Employees report tips to the employer

Employees who receive $20 or more in tips in a month while working for one employer must report them to that employer by the 10th day of the following month. They can use Form 4070 or an electronic system the employer provides. Tips include cash tips, card tips and tips received through tip sharing.

The employer's withholding duties

On reported tips, the employer:

  • Withholds federal income tax and the employee's share of Social Security and Medicare taxes
  • Pays the employer's share of Social Security and Medicare
  • Reports tips on Form 941 and the employee's W-2

Withholding on tips comes from the employee's regular wages or other funds the employee provides. If there is not enough, uncollected Social Security and Medicare taxes are reported on the W-2.

Card tips

Tips added to card payments pass through the business. Record them in a tips payable account, not as revenue, and pay them to employees, usually through payroll. Processing fees on the tip portion are a business decision subject to state law.

Service charges are not tips

A mandatory charge added to the bill, such as an automatic gratuity for large parties, is generally a service charge, not a tip, if the customer did not freely decide the amount. Service charges paid to employees are regular wages. The distinction affects withholding timing and the tip credit.

Large food or beverage establishments

Certain food or beverage businesses where tipping is customary and that normally employ more than 10 employees on a typical business day must file Form 8027 annually, reporting receipts and tips and, in some cases, allocating tips.

Tip credits

Food and beverage employers may be eligible for a credit for part of the employer Social Security and Medicare taxes paid on tips. Your preparer will review eligibility. Federal minimum wage rules for tipped employees are described in the Department of Labor's fact sheet on tipped employees.

Recent federal changes

Recent legislation created a temporary federal income tax deduction for qualified tips claimed by eligible workers and added reporting for employers. The IRS publishes guidance on its Working Families Tax Cuts page; check it for current employer reporting requirements.

See our pages on payroll for restaurants and salons.

Monthly tip reconciliation

Compare tips reported by employees with charged tips from card reports. Large gaps may indicate unreported tips and should be addressed with staff.

Keep the monthly tip reports employees give you, along with card tip reports, for your records.

Train new staff on tip reporting during onboarding so expectations are clear from the first shift.

Key terms

Definitions for terms used in this guide, from our small business glossary:

  • Debits and Credits: Debits and credits are the two sides of every bookkeeping entry; each account type increases on one side and decreases on the other.
  • Tax Credit vs Tax Deduction: A deduction reduces taxable income; a credit reduces the tax itself, dollar for dollar.