Restaurant Owner’s Guide to Tipped Employees
Tips are a time-honored tradition in the restaurant industry, but they’re also a bit of a headache when it comes to payroll. Let’s take a look at some of the challenges that allowing tips brings up – and what you can do about them.
Yes, employees do need to be honest about how much they make in tips each day. The problem for employers, of course, is that employees may be tempted to lie about this as a way of improving their personal finances. If they can pick up $10 an hour in tips and an extra $5 by claiming they received less than they really did, they could wind up with far more take-home pay than you bargained for.
The IRS can help with this. Publication 1244 includes two forms that can be used to keep a daily record of tips received. Ask your employees to use these, and double-check every now and then to be sure that they’re reporting it accurately.
Employees who receive tips are still required to be paid at least the Federal Minimum Wage. As an employer, you are allowed to take a Tip Credit on their wages and pay them a minimum of $2.13 an hour (in most states) as long as they receive enough tips to make up the difference. If they do not receive enough in tips to cover the difference, you must cover that cost and pay them the difference. This is why accurate tip reporting is so essential.
Also, note that overtime wages must be calculated based on the full minimum wage, not the wage after the tax credit has been applied.
Taxes on Tips
As an owner, you are required to pay taxes on the cash tips that your employees receive. Non-cash tips (such as tickets to an event) are not subject to taxation, nor are monthly tip totals of under $20. Honestly, that’s only likely to apply to young employees working minimal part-time hours – so don’t expect employees to make so little in tips that you don’t have to pay taxes on them.
Note that many automatic gratuities – especially those of 18% or more – are considered income for the restaurant, not the employee, and sales tax applies to them.
Many restaurants employ a system where employees contribute their tips to an overall pool that’s then shared among all members. That’s a good thing – if you know how much each employee should be getting from the pool, it’s easy to catch people who lie about it.
Employees only need to report their income after the allocation, not before – under this system, they haven’t ‘earned’ the tip until it’s been allocated.
Some restaurants offer meals to employees. The value of these meals can be removed from their wages – and thus rendered non-taxable – if and only if:
- The meals are provided on the premises of your business
- The meals are provided for your own convenience.
As explained by the IRS, all meals that happen immediately before, during, or immediately after an employee’s working hours are considered to occur for your convenience. In the practical sense, this means that it’s usually more affordable to feed employees than it is to pay them – and indeed, the promise of getting good meals every day can be a great employee incentive.
Disclaimer: While the information presented here is true and accurate to the best of our knowledge, laws may vary in different jurisdictions, or they may have been changed since the last time this content was updated. If you have any further questions about how tipping impacts you, talk to a qualified attorney.