January 15, 2020 - Douglas Myser

Guide for reporting tip income. Employers and employees in the service industries that involve tipping need to comply with a unique set of tax rules. Like wages, income tax, Social Security tax and Medicare tax must be paid on tip income. Tax professionals can share the following guide with clients and prospects to educate and encourage them to stay compliant with the rules. In general, tips are discretionary payments made by customers to employees and can be paid in cash, credit cards, noncash and through tip pools from other employees (indirect tips). To qualify, the tip must be voluntary, and the amount cannot be negotiated. On the other hand, service charges are required to be paid by the customer even if it's called a tip or gratuity. Examples of service charges, include an automatic gratuity for a large dining party, a banquet event fee, a hotel room service charge and a bottle service charge. In general, service charges are reported as non-tip wages paid to the employee, excluding the portion retained by the employer. Guide for reporting tip income.

Employees must report all cash tips received to the employer, except total tips under $20 for a given month. Employees need to report tips to the employer by the 10th of the month after the month the tips are received. Noncash tips received from customers are not reported to the employer. All cash and noncash tips are required to be included in the employee's gross IRS income and are subject to tax. Both direct tips and indirect tips must be reported to the employer, but you can reduce the number of reportable tips you share with other employees.

If the total tips reported by all employees are less than 8 percent of gross receipts, the employer is required to allocate the difference between 8 percent of gross receipts and the actual tip income among all employees who received tips.

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