Do your employees ever receive tips?
When you think of tipped employees, the first kinds of jobs that springs to mind may be those in the hospitality sector, like servers and bartenders at restaurants, delivery drivers, or baristas. Yet, there are plenty of industries where employees may receive tips; for example, casino employees, hairstylists, nail technicians, taxicab drivers, dog groomers, entertainers, and more.
However, just because an employee receives a tip doesn’t necessarily mean the Department of Labor and the IRS officially designate them as a “tipped employee.”
As an employer, it’s essential that you understand the difference, for tax purposes, between an employee who may occasionally get a tip and one whose tipped income is subject to IRS reporting requirements and regulations that dictate how you handle their pay.
Keep reading to discover what you need to know as an employer about tipped employees and taxes.
The Department of Labor (DOL) explains that a tipped employee is one who customarily and regularly receives more than $30 per month in tips, which can come from credit cards, debit cards, or cash.
If an employee usually receives less than that amount, and if tips are not frequent or customary to their occupation, they are not considered a tipped employee for tax purposes — even if they occasionally earn a gratuity.
As an employer, the Fair Labor and Standards Act (FLSA) only requires you to pay tipped employees a minimum of $2.13 per hour in direct wages, as long as that amount, combined with the employee’s tips, equals the federal minimum hourly wage.
If it does not, you as the employer must make up the difference.
It’s worth noting, additionally, that many states or cities require a higher minimum direct wage for tipped employees in some sectors than the FLSA does. In contrast, others do not distinguish between the minimum wage for tipped and non-tipped employees. For example, Arizona’s tipped minimum wage is $9.15, and Alaska’s minimum wage is $10.34 for tipped or non-tipped employees alike. Meanwhile, in New York City, the minimum wage for food service workers is $15 per hour.
The IRS considers all tips exceeding $20 per month that tipped employees receive to be income. As such, they are subject to federal income tax.
That means the employee must include in gross income all tips they receive directly, charged tips paid to them by their employer, and their share of any tips received under a tip-splitting or tip-pooling arrangement.
The IRS requires both, directly and indirectly, tipped employees to report all tips over $20 per month to their employer and any unreported tips on their individual income tax return.
On the other hand, if the total amount of tips that an employee receives in a single month and through a single employer does not exceed $20, they are not taxable, and the employee does not need to report them as income.
For tax purposes, tips do not only include cash given directly to the customer or left for them through electronic payment methods and tip amounts paid out through pool or sharing systems, but also the value of any noncash tips (such as tickets or other items of value).
Finally, all cash tips exceeding $20 that an employee receives in any calendar month are subject to social security and Medicare taxes. (As above, amounts lower than $20 per month are not subject to these taxes.)
Employers have some obligations regarding employee tip income, as well. These include recordkeeping and reporting responsibilities, like keeping employee tip reports on record.
Furthermore, employees must withhold taxes (including income, Social Security, and Medicare taxes) based upon an employee’s wages and tip income and deposit this tax.
Finally, employers must also pay a share of Social Security and Medicare taxes based on the total wages paid to tipped employees, as well as the reported tip income, and report this information and tax to the IRS by filing the appropriate paperwork.
If an employee does not report tips to their employer, the employer is not liable to withhold and pay the employee’s share of Social Security and Medicare taxes nor for their employer’s share of taxes on those unreported tips. However, if the IRS subsequently notifies the employer of a demand to pay taxes on unreported tips, the employer would become liable at that time.
The employer is obligated to withhold a 0.9% Additional Medicare Tax from any Medicare wages or RRTA compensation it pays to an employee exceeding $200,000 in a calendar year, regardless of their filing status. This Additional Medicare Tax is only imposed on the employee and not the employer.
Generally, the employee must report tips allocated to them by their employer using Form 4137, Form 1040, or Form 1040-SR. The employee must also report other tips not reported to the employer on Form 4137.
Nevertheless, an employer who operates a large food or beverage establishment must file Form 8027, an annual report of tip income and allocated tips. Moreover, some employers who operate multiple food and beverage establishments must file multiple Forms 8027.
As touched upon above, the average pay rate for a tippled employee is equal to the amount of direct cash wages plus the tip credit amount claimed by the employer.
A tip credit is essentially the mechanism that makes it possible for an employer to include tips in minimum wage calculations by crediting the amount of the tip against the employer’s requirement to pay a minimum wage.
Employers can only apply tip credits to tipped employees. They can further apply them to payment obligations for hours of work that produce tips directly or support tip-producing work (as long as this type of work is not performed for a long time).
State laws differ when it comes to tip credits, too. For example, California, Nevada, Minnesota, Montana, Oregon, Alaska, and Washington prohibit tip credits, whereas other states allow it but require a higher minimum wage (as mentioned previously). Complicating matters further, other states have their own parameters for when an employer may take a tip credit, which differs from those defined by the FLSA.
Check the DOL website and your state’s website to find guidance and information when in doubt.
Another area employers may find confusing is the calculation of overtime for tipped employees. The FLSA requires employers to pay extra wages for work that exceeds 40 hours in a given week. But the nature of tipped employee minimum wage and tip credits can make this a bit less straightforward.
Assuming a $2.13 tipped minimum wage, to calculate overtime, an employer would need to subtract the employee’s hourly tip credit from the general (not tipped) hourly overtime pay rate and multiply the number of hours of overtime by the employee’s hourly overtime pay.
To make it simpler: the federal general minimum wage is $7.25 per hour. Most employees receive an overtime rate of one and a half times their regular rate, which equals $10.88 per hour in this example. If the employee worked forty-five hours in a given week, or five hours of overtime, the employer would multiply those five hours by the employee’s hourly overtime pay with the total hourly tipped credit subtracted.
The maximum hourly tip credit permitted under federal law is $5.12. Subtracted from the $7.25 minimum wage, which yields a non-overtime pay rate of $2.13, and an overtime pay rate of $5.76 per hour. Therefore, applying that amount to our example (five hours of overtime multiplied by $5.76 an hour of overtime pay), the overtime pay amount would come to $28.80.
If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.
If you aren’t a client, why not? We can take care of your accounting, bookkeeping, tax, and CFO needs so that you don’t have to worry about any of them. Interested? Contact us here to set up a no-obligation consultation.
Interested in receiving updates in your mailbox? Check out our newsletter, full of information you can use. It comes out once every two weeks, and you can register for it below.
Found this article helpful? Share it with your network.
Above & Beyond
New York City
2 West 45th Street, Suite 1208
New York, New York 10036
565 Taxter Road, Suite 105,
Elmsford, New York 10523
Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
Send us a message and we will contact you as soon as possible.