Payroll processing for any company presents challenges, but for companies whose employees receive tips, proper and accurate payroll administration is even more complicated. The good news for employers in most states is that tips can be counted as part of an employee’s pay for purposes of complying with minimum wage laws. The bad news is that accounting for tip income for tax purposes adds an additional layer of paperwork and reporting and relies on the cooperation of employees for accuracy.
The Fair Labor Standards Act makes an exception to the minimum wage law for any employee who is “engaged in an occupation in which he or she customarily and regularly receives more than $30 a month in tips.” Examples of businesses whose employee payroll would include customarily tipped workers are restaurants and bars, hotels, resorts, country clubs and casinos, to name some of the most obvious.
Under federal law, an employer can pay a tipped employee as little as $2.13 per hour, as long as his or her tip income is sufficient to bring the employee’s total earnings up to minimum wage. With the federal minimum wage currently at $7.25, employers can thus claim a “tip credit” up to $5.12 per hour. Some states however, have legislated lower tip credits. For example, Hawaii allows a maximum tip credit of only 25 cents per hour. Tip credits are not allowed at all in Alaska, California, Minnesota, Nevada, Oregon and Washington.
The high rate of payment by credit card and debit card has made tracking tips easier, but customers still leave many cash tips. While employees are required to regularly report cash tips to their employers, they naturally have financial incentives to underreport them. Needless to say, this is not OK with the Internal Revenue Service, which tries to root out tip underreporting in order to collect both income taxes from employees and payroll taxes from employers.
Most food and beverage establishments with tipped employees must file Form 8027 with the IRS, which compares reported tips to gross receipts. Form 8027 basically assumes that the overall rate of tipping in a restaurant would never be below 8 percent. If total reported tips don’t equal at least 8 percent of gross receipts, additional tip income is “allocated” to employees using one of several different methods. Note that even percentages above 8 percent might trigger a tip examination by the IRS if the agency has reason to believe that tips are being significantly underreported.
One way the Internal Revenue Service tries to encourage accurate tip reporting is by entering into voluntary enforcement agreements with businesses. An employer agrees to take very proactive steps to ensure that employee tip reporting is as accurate as possible; in return the IRS agrees to audit individual employees suspected of underreporting tips rather than first going after the employer for the unpaid FICA taxes on the tip income. These agreements may obligate an employer to take steps such as:
- Educating employees about tip reporting laws
- Establishing clear tip reporting procedures
- Entering into tip reporting agreements with employees
- Distributing blank forms for employees to record their tips daily, such as IRS Form 4070
- Providing information on underreporting employees to the IRS
Minimum wage regulations and tax reporting compliance are only two of the issues that payroll managers must contend with when a business has tipped employees. Payroll outsourcing to a payroll specialist frees a busy business owner from the time and paperwork involved in complying with labor and tax laws relating to tipped employees. The professionals at Padgett Payroll Services can handle these and other payroll issues so that you don’t have to. To find out more about how we can lift the many burdens of payroll management off your shoulders, call Padgett today at (706) 548-1040.