Collecting, Reporting and Paying Taxes on Employee Tips & Service Charges As Required by Tax Law

Employers have multiple obligations regarding employee tip income including recordkeeping and reporting responsibilities, collecting taxes on tips, filing certain forms and paying or depositing taxes.

Generate & retain employee tip income reports.
Withhold and deposit income tax, social security and Medicare based on wages and tip income.
Pay employer share of social security and Medicare taxes based on the total wages paid to tipped employees as well as the reported tip income
Report to the IRS on the appropriate forms
- Form 941 – Employer’s Quarterly Federal Tax Return
- Form 940 – Employer’s Annual Federal Unemployment (FUTA) Tax Return

Tips from Customers

Customer payments are only considered tips under these conditions:

Payment must be of customer’s own free will (not coerced or mandatory);
Customers have unrestricted right to determine amount of tip;
Payment is not negotiatiable or dictated by employer policy;
Customers generally determine who receives the tip amount.

Employees are entitled to keep all of their tips. If your business collects tips on credit or debit cards, you must reimburse employees for those amounts.

Service Charges ≠ Tips

Let’s say a restaurant automatically adds 18% gratuity to the check for large parties. Since it is a mandatory fee (regardless of what the business calls it) that is a service charge, not a tip.

Service charges should be treated as employee wages when distributed, or employer income if retained.