TIP REPORTING
Background Information:
Employers are not required to pay FICA tax (social security and medicare taxes) if an employee’s tips are less than $20 per month or if his/her wages exceed the FICA annual wage base. A restaurant is responsible for paying FICA tax (7.65%) on taxable employee wages and tips. Employees are required to report tips on Form 4070 Employee’s Report of Tips to Employer (or employer custom designed form)for proper withholding of employee income tax, FICA tax, and correct payment of the employer FICA tax. Noncash tips, such as tickets and passes, are not reported to the employer and not subject to FICA tax.
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Professor Robert Ragsdale, CPA sent in an article from the Journal of Accountancy, July 2000 written by Lesli S. Laffie, JD. LLM, Technical Editor, The Tax Adviser. Following is an abstract of that article.
Under regulation section 31.3111-3, an employer must pay FICA taxes on tips as reported by employees. However, if the employee tips are under-reported, regulation 3121(q) comes into play. This regulation states that if the IRS ascertains that tips have been under-reported, a notice and demand payment can be sent to the restaurant owner for payment of FICA tax on those under-reported tips.
The unreported tip income is assessed by an IRS audit on the restaurant and not individual employees. The employer share of FICA is based on an aggregate amount of unreported tips using a method known as the aggregate method. Basically this method arrives at sales per hour number, which is then multiplied by each server’s hours worked to determine yearly sales; this yearly sale is then multiplied by an average tip rate; the tips and sales charged on credit cards determine this tip rate.
Federal Circuit Courts of Appeal have upheld the IRS use of this indirect method. Some district courts have sided with restaurants. Those courts concluding in favor of restaurants have based their decisions on the following examples:
Comments from Ray Cote:
To protect themselves from unfavorable IRS treatment and court decisions, a restaurant owner should:
Background Information:
Employers are not required to pay FICA tax (social security and medicare taxes) if an employee’s tips are less than $20 per month or if his/her wages exceed the FICA annual wage base. A restaurant is responsible for paying FICA tax (7.65%) on taxable employee wages and tips. Employees are required to report tips on Form 4070 Employee’s Report of Tips to Employer (or employer custom designed form)for proper withholding of employee income tax, FICA tax, and correct payment of the employer FICA tax. Noncash tips, such as tickets and passes, are not reported to the employer and not subject to FICA tax.
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Professor Robert Ragsdale, CPA sent in an article from the Journal of Accountancy, July 2000 written by Lesli S. Laffie, JD. LLM, Technical Editor, The Tax Adviser. Following is an abstract of that article.
Under regulation section 31.3111-3, an employer must pay FICA taxes on tips as reported by employees. However, if the employee tips are under-reported, regulation 3121(q) comes into play. This regulation states that if the IRS ascertains that tips have been under-reported, a notice and demand payment can be sent to the restaurant owner for payment of FICA tax on those under-reported tips.
The unreported tip income is assessed by an IRS audit on the restaurant and not individual employees. The employer share of FICA is based on an aggregate amount of unreported tips using a method known as the aggregate method. Basically this method arrives at sales per hour number, which is then multiplied by each server’s hours worked to determine yearly sales; this yearly sale is then multiplied by an average tip rate; the tips and sales charged on credit cards determine this tip rate.
Federal Circuit Courts of Appeal have upheld the IRS use of this indirect method. Some district courts have sided with restaurants. Those courts concluding in favor of restaurants have based their decisions on the following examples:
- Section 3121(q) allows the IRS to demand FICA tax on tips for unreported tips; it does not allow aggregation estimates.
- The aggregate method does not take into account the $20 de minimis rule.
- IRC Section 6053(c)(3) states restaurant employers are to determine if the employee reported tips are less than 8% of gross receipts. Reported tips not meeting that threshold are to be allocated among tipped employees in one of the following three methods:
- hours worked
- gross receipts
- good-faith agreement
Comments from Ray Cote:
To protect themselves from unfavorable IRS treatment and court decisions, a restaurant owner should:
- Educate themselves by reading IRS publication 1875 (A Guide to Tip Income Reporting for Employers in the Food and Beverage Industry) http://www.irs.gov/pub/irs-pdf/p1875.pdf
- Employers should be familiar with publications 531(Employee Tip Reporting) http://www.irs.gov/pub/irs-pdf/p531.pdf and publication 1244 (Employees Daily Record of Tips and Report to Employer) http://www.irs.gov/pub/irs-pdf/p1244.pdf
- Educate employees about proper tip reporting. Give them IRS publication 1872 (A Guide to Tip Income Reporting for Employees in the Food and Beverage Industry) http://www.irs.gov/pub/irs-pdf/p1872.pdf
- Have employees use IRS form 4070 or a suitable in-house replacement
- Follow section 6053(c)(3) and file IRS form 8027 as necessary. http://www.irs.gov/pub/irs-pdf/f8027.pdf
- For more information: refer to Chapter 5, Hospitality Payroll Accounting, Accounting for Hospitality Managers
