Insights for Employers on Taxes and Service Tips
Posted by Jennifer Maloney on February 10, 2025
Businesses in certain industries, such as restaurants, hotels, and salons, often employ service workers who receive tips as a significant part of their compensation. Compliance with federal and state tax regulations is crucial if your business has employees who receive tips.
Current Status of Tip Taxation
During the campaign, President Trump promised to end taxes on tips. While this proposal generated buzz among employees and some business owners, no legislation eliminating taxes on tips has been passed. For now, employers should continue to follow the existing IRS rules until the law changes — if it does. Unless legal changes are enacted, the status quo remains in effect.
Defining Tips for Tax Purposes
Tips are optional and can be either cash or noncash. Cash tips are received directly from customers, electronically paid tips distributed to employees by employers, and tips received from other employees in tip-sharing arrangements. Workers must generally report cash tips to their employers. Noncash tips are items of value other than cash, such as tickets, passes, or other items received from customers. Workers don’t have to report noncash tips to employers.
Criteria for Tip Classification
Four factors determine whether a payment qualifies as a tip for tax purposes:
- The customer voluntarily makes a payment.
- The customer has an unrestricted right to determine the amount.
- The payment isn’t negotiated with, or dictated by, employer policy.
- The customer generally has a right to determine who receives the payment.
Types of Tips
A direct tip occurs when an employee receives it directly from a customer (even as part of a tip pool). Directly tipped employees include wait staff, bartenders, and hairstylists. An indirect tip occurs when an employee who normally doesn’t receive tips receives one. Indirectly tipped employees can include bussers, service bartenders, cooks, and salon shampooers.
Record-Keeping Requirements
Tipped workers must keep daily records of the cash tips they receive. They can use Form 4070A, Employee’s Daily Record of Tips, found in IRS Publication 1244. Workers should also keep records of the dates and values of noncash tips. The IRS doesn’t require workers to report noncash tips to employers, but they must report them on their tax returns.
Reporting Tips to Employers
Employees must report tips to employers by the 10th of the month after the month they were received. The IRS doesn’t require workers to use a particular form to report tips. However, a worker’s tip report generally should include the employee’s name, address, Social Security number, and signature; the employer’s name and address; the month or period covered; and the total tips received during the period. If an employee’s monthly tips are less than $20, there’s no requirement to report them to the employer, but they must be included as income on the tax return.
Employer Responsibilities
Employers must send each employee a Form W-2 that includes reported tips. Additionally, employers must keep employees’ tip reports, withhold taxes based on employees’ wages and reported tip income, pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as reported tip income, report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return, and deposit withheld taxes in accordance with federal tax deposit requirements. Large food or beverage establishments must also file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, disclosing receipts and tips.
Tip Tax Credit
Employers with tipped workers providing food and beverages may qualify for a valuable federal tax credit involving the Social Security and Medicare taxes paid on employees’ tip income.
Staying Compliant
Running a business with tipped employees involves more than just providing good service. It requires careful adherence to wage and hour laws, thorough recordkeeping, accurate reporting, and an awareness of changing requirements. While President Trump’s pledge to end taxes on tips hasn’t yet materialized into law, stay alert for potential changes. In the meantime, continue meeting all current requirements to ensure compliance.
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Jennifer is welcomed to the Firm with nine years of experience in public accounting. She is part of our Outsourced Accounting Services division, helping commercial business owners with bookkeeping and general ledger maintenance, business process outsourcing, and strategic planning and analysis. Jennifer has previous experience as an Assistant Controller.