Many employees receive tips.
Tips are taxable income and the tips employees get from customers are generally subject to withholding.
By the 10th of each month the employees must report to you the tips they received in the prior month.
In other words if they received tips in April, they would be reported to you by May 10th.
This includes cash tips and tips charged on credit cards or to accounts.
However, if the total month's tips are less than $20 they would remain taxable to the employee but would not need to be reported to you.
If your employees get tips Form 4070, Employee's Report of Tips to Employer, is a great tool to give them to assist them in their reporting requirements.
It comes in Publication 1244, Employee's Daily Record of Tips and Report to Employer.
This includes a daily log they can complete and the form 4070 they use to report their monthly totals to you.
There are also helpful instructions for recording and reporting tip income.
Some employees are reluctant to report the full amount of tips, but in the long run it's actually to their benefit to report all of their tips.
Tip reporting increases their social security credits which helps them maximize their social security and Medicare benefits at retirement.
And may make them eligible for higher amounts of unemployment benefits and worker's compensation.
Another benefit to accurately reporting income is that it may increase the chance of receiving financing for a home, car, or other necessities.
As the employer you must collect income tax, employee social security tax, and employee Medicare tax on the tip income your employees report to you.
You can collect these taxes from wages or from other funds your employee makes available.
If the employee receives regular wages and reports tips, figure income tax as if the tips were supplemental wages or a part of regular wages.
If you have not withheld income tax from the regular wages because the wages were too low, add the tips to the regular wages and withhold income tax based on the total.
But if you have withheld income tax from the regular wages, you then have two options available.
You can withhold a flat 27% or you can add the tips and regular wages for the most recent payroll period and figure the income tax withholding as if the total were a single payment.
Then subtract the tax already withheld from the regular wages and withhold the remaining tax from the tips.
Why wouldn't you just withhold 27%, it's so much easier?
If the employee's income is below the 27% income tax bracket, calculating their tax using the 27% flat rate may mean that you're withholding a lot more tax than is necessary.
This could cause a hardship for the employee.
Try to consider this before using the flat 27% withholding method.
There may be times when an employee's regular wages may not be enough for you to withhold all the taxes owed on the regular pay plus reported tips.
If this happens, the employee can give you money until the close of the calendar year to pay the rest of the taxes.
If there is not enough money to cover all the taxes, withhold taxes in this order: all taxes on regular pay, then social security and Medicare taxes on reported tips, and finally income taxes on reported tips.
Collect any taxes that remain unpaid from the employee's next paycheck.
If taxes remain uncollected at the end of the year the employee may be subject to a penalty.
Some employees receive allocated tips.
These are tips you assign to an employee in addition to the tips the employee reported to you for the year.
Do this only if: your business is a restaurant, cocktail lounge or similar business that must allocate tips to employees and tips the employee reported are less than 8% of their share of the food and drink sales for the business.
Show the allocated tips separately in box 8 on the W-2.
Don't include allocated tips in box 1 with wages and reported tips.
Publication 531 Reporting Tip Income can give you more details on allocated tips.
You can look at it or order it on our web site at irs.gov.
Or by calling 1-800-tax-form.
Calculating allocated tips can be a difficult process.
But the IRS can help make it easier.
If your employees receive tips you can participate in the tip rate determination and education program.
The IRS has several tip agreements to help employers and employees understand and meet their tip reporting responsibilities.
All are voluntary.
The two most common agreements are the tip rate determination agreement, or TRDA and the tip reporting alternative commitment or TRAC.
We encourage you to contact your local IRS office for further assistance.
The local office can conduct an onsite workshop on tip income reporting or discuss establishing tip agreements.
You can also go to irs.gov/smallbiz and do a search on TRDA or TRAC for additional information on TRDAs and TRACs.
This online information is also useful for explaining tip income reporting to your employees and it also helps you understand tip agreements.
For resources discussed in each lesson, please visit the Lesson 10 Supplement.
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