Tip Distribution and Tip Reporting
Posted on February 10, 2014
In most restaurants, servers receive tips from the customers they serve. In the United States, it is customary and expected to tip servers. These food service employees depend on tips to supplement a lower hourly wage. In most cases, tips make up the bulk of a server’s annual wage. Because of this, the food and beverage industry, and the government, have outlined a strict set of policies for the food service employer and the food service employee. These policies define how a business owner will go about tip distribution and tip reporting.
How tips are distributed depends on the size, type and ownership of the restaurant. Individual restaurant owners or restaurant ownership groups will determine how tips are distributed among staff members.
How do restaurants distribute tips?
This question can be answered in more than one way. The answer depends on a specific factors such as the type of establishment and payment system.
- Quick-service restaurants often have a tip jar, from which cash is distributed each shift – based on hours worked.
- Bars or bartenders in restaurants will often pool their cash tips for equal distribution after a shift.
- In full-service and fine-dining restaurants servers mainly keep and report their own cash tips. Credit card tips are typically accounted for through the POS system and are distributed to the server in their paycheck, with taxes deducted.
- Support staff such as bussers, food expediters, hosts and bartenders typically receive a tip-out from the waitstaff in amounts varying from 5-10%.
Who receives tips?
Restaurant servers, bussers, bartenders, food-runners, cashiers and hosts customarily receive tips in addition to their hourly wages. Managers are not usually eligible to receive tips as they are typically paid on salary.
How do tip-outs work?
Often, servers are designated to distribute a portion of the day’s tips to other front of the house (FOH) staff. This is called a tip-out. Some restaurants mandate this practice and even maintain a set percentage that the FOH staff members always receive.
If your restaurant does not distribute tips through a payroll system, then it is the server’s responsibility to report their tips – cash and credit – accurately. If a server is reporting their own tips they must:
- Keep a daily record of all tips received
- Use the IRS publication 1244 to record all tips for the year
This is not as straightforward or simple as it seems. Since tips are subject to tax, servers are known to report less money in cash tips than they actually receive. Thus, decreasing their income by underreporting this portion of their taxable income.1 Additionally, if the reported tip amount is less than eight percent of the total sales receipt, this could result in further wage allocation from the employer. For a server, the opportunity to make more income while paying fewer taxes is an attractive one.
Largely in order to avoid in-house underreporting issues, employers and managers have some strict requirements when it comes to tip reporting. Employers must essentially do four things to make sure they are following the law and doing their jobs:
1. Receive tip reports
Employers must receive a tip report from each employee for every payroll period (or more often if desired).
2. Withhold Income and FICA taxes
They must withhold Income and FICA taxes from each employee’s paycheck and report each employee’s tips to the IRS3. Report all tips for the month no later than the 10th day of the month following the month the tips were received.
3. File Form 8027
If the restaurant is considered a large business,* then they must also file Form 8027 with the IRS at the end of every year. This is a document that summarizes the restaurant’s charged sales, total sales, charged tips and total reported tips.
4. Allocate necessary wages
If the total reported tips do not add up to eight percent of the total sales, then the restaurant must go through a tip allocation process. This means that a manager is required to retro-pay more wages to the servers who recorded too few tip earnings (below eight percent of their sales).4
Essentially, employers are responsible reporting to the IRS during each pay period. If for some reason the reported amount of tip income is less than eight percent of the total receipts, then the restaurant must allocate the non-taxable difference to the employee in the form of extra wages. Check out Form 8027 for more information, as this can get complicated.
Educate your staff
It is important to educate servers of the necessity to report their tips to managers as accurately as possible. Falsifying tip income is against the law. In the odd chance that the IRS notices a problem like this—usually substantiated by reporting tips under that “red flag” of eight percent of the total restaurant sales—then it may audit the restaurant.5 No manager wants to taint their business by micromanaging tip reports, but one way to solve the issue responsibly is to educate employees about the potential consequences of an IRS audit.
Warn employees of the risk
A restaurant or a server could face penalties such as fines or even jail6 if it is determined that tip money has not been honestly reported.
Emphasize the point in staff meetings
Employers can try to emphasize correct tip reporting in every staff meeting. Repetition is a great way to drive home the point.
Suggest further training
A manager might say that if servers are not reporting tips, then the servers must not be getting them, in which case they must not be doing their job correctly. Then the employer may require a program of additional training to prove they mean business. Teach the staff to report every dime in order to keep themselves—and the establishment—safe from repercussions.
Rely on Point of Sale Technology
Most retail establishments use computerized technology for their financial transactions, merchandise inventory, labor management and of course, tip reporting. These computers are known as Point of Sale (POS) systems.
Program the POS
Employers should program their POS system to prompt a message requiring servers to “report all tips” before allowing them to clock out from their shift. The employer might be able to set a “threshold” of cash tips at a certain percentage, so that employees who are not reporting enough or truly did not receive enough can come to the manager to discuss it first.
Analyze Data from the POS
The POS system should afford managers and owners the opportunity to track sales and charge tips according to the server. The POS also affords the manager the opportunity to run reports and analyze this information to help make it even easier to monitor tip reporting. *A worksheet for determining whether a business meets the criteria listed above is included in the Instructions for Form 8027. However, these criteria typically include a)food or beverage is provided for consumption on the premises, b) tipping is a customary practice, and c)more than 10 employees, who work more than 80 hours, were normally employed on a typical business day during the preceding calendar year.