Tips on Tips Legal and Tax Issues Regarding Tips
June 25, 2014
Marney Zellers, CHAE Hospitality Specialist
Tips on Tips Overview
• Tips vs. Service Charges
• Tip Pools and Tip Sharing
• Tip Reporting and Tip Income Audits
• Best Practices
Tips on Tips Internal Revenue Code History
1965: IRC requires
employers to withhold FICA
tax on tips from employees’ pay, but employers did not have to pay a matching
amount
1977: IRC requires
employers to pay its share of
FICA tax on tips, but only up to the minimum
wage
1982: IRC requires
employers whose
employees fail to report at least 8% of
gross sales as tips to allocate tips to this level
1987: Congress
amends IRC to require
employer portion of FICA tax on all tips
1993: FICA tip credit
enacted - employers
allowed a tax credit for the FICA taxes
paid on their employee tips
1993: IRS introduces the Tip Rate
Determination/Education Program (TRDEP) to
encourage employees to report the correct
amount of tip income to their employer.
2002: Supreme Court rules the IRS can
determine the amount of tips it thinks employees should have reported based on restaurant
data and can assess the employer share of FICA
tax on suspected unreported tips
2013: IRS enforces Revenue Ruling 2012-18, clarifying their
distinction between tips and service
charges and their treatment of each
QUESTION
Tips on Tips Tips vs. Service Charges
Service charges differ from tips in the following way:
a) Tips are subject to the employer matching FICA tax but service charges are not.
b) Tips can be considered toward minimum wage in states with a tip credit while service charges may not.
c) Service charges belong to the employer while tips belong to the employee.
d) All of the above.
Tips on Tips Tips vs. Service Charges
Tips vs. Service Charges - Defined Tips Service Charges
Payment is free from compulsion Payment is required
Customer has unrestricted right to determine amount
Amount is determined by someone other than customer
Generally, the customer has the right to determine who receives the payment
Someone other than the customer determines who receives the payment
Tips on Tips Tips vs. Service Charges
Tips vs. Service Charges - Treatment Tips Service Charges
Reported to IRS as tip income and eligible for the FICA tip credit
Reported to IRS as wages and not eligible for the FICA tip credit
Legally belong to the person for whom the customer intended payment. Employer distribution of tips to those other than said person are limited.
Legally belong to employer. Treated as income and subject to sales tax in applicable states. Employer retention and distribution of payments more liberal.
Count toward meeting minimum wage requirement in states with tip offset (tip credit)
Count toward meeting minimum wage requirement in states with tip offset (tip credit) Included in hourly rate used to determine overtime rate
Tips on Tips Tips vs. Service Charges
AUTOMATIC GRATUITY • Commonly referred to as “Auto Grat” • Commonly added to restaurant checks of larger parties • Automatic gratuity policies are commonly written on menus and verbalized by
front desk staff • IRS Rev. Ruling 2012-18 declares auto grat to be a service charge, not a tip
QUESTION Tips on Tips Tip Pools and Tip Sharing
A reasonable tip pool, according to the US Dept. of Labor, includes the following:
a) Employers may require directly tipped employees to share service charges such as auto gratuity, but not discretionary tips.
b) Employer may require directly tipped employees to share up to 15% of all their tips with other employees involved in the service of the customers
c) Salaried managers may be included in a tip pool as long as they are directly serving the customers
d) None of the above
Tips on Tips Tip Pools and Tip Sharing
Tip Pools and Tip Sharing – Definitions Tip Pool Tip Share
All tips collected and distributed by “house” Tipped employee required to share a percentage of tips with other employees
Tips on Tips Tip Pools and Tip Sharing
Mandatory Tip Pools and Tip Sharing – Who Can and Cannot Partake
Can Cannot Food and beverage servers (waiters, waitresses, cocktail servers) Owners or managers
Bartenders Cooks or chefs
Bussers and bar backs Dishwashers
Hosts and greeters Laundry room attendants
Counter personnel Janitors
Bellhops “The house”
Some hourly supervisors
Some sushi and teppanyaki chefs
Tips on Tips Tip Pools and Tip Sharing
Tip Pools and Tip Sharing – Department of Labor Rules and Regulations
Permissible as long as the employees sharing in the tips have somehow participated in serving of the customers who left the tips Legally belong to the person for whom the customer intended payment. Employer distribution of tips to those other than said person are limited. Count toward meeting minimum wage requirement in states with tip offset (tip credit). Employer may only take a tip credit for the amount of tips each employee ultimately receives.
Employer must notify its employees in advance of any required tip pool contribution amount.
Employer may not retain any of the employees' tips for any other purpose.
Department of Labor tip pool/tip share rulings do not apply to employer mandated service charges.
Tips on Tips Tip Pools and Tip Sharing
Tip Pools and Tip Sharing – The Mario Batali Case
STEPHANIE CAPSOLAS, et al v. PASTA RESOURCES, INC., et al Class action lawsuit claiming employees were required to tip out 4-5% of wine sales to support the wine program.
Employees claimed the proceeds went to “the house”. The judge agreed.
Batali’s group agreed to pay $5.25 million in restitution.
Tips on Tips Tip Pools and Tip Sharing
Tip Pools and Tip Sharing – Cumbie v. Woody Woo and Oregon Restaurant Association et al v. Solis
Ninth Circuit Court of Appeals – Jurisdiction includes California, Nevada, Washington, Oregon, Alaska, Idaho, Montana, Hawaii, and Arizona An employer can require servers to pool their tips with non-tipped kitchen and other “back of the house staff,” so long as a tip credit was not taken and the servers were paid minimum wage. In 2011, the DOL issued regulations that directly conflicted with the holding in Woody Woo. As a result, employers could no longer require mandatory tip pooling with back-of-the-house employees. Shortly after the 2011 regulation, the National Restaurant Association, Washington Restaurant Association, Oregon Restaurant and Lodging Association, and Alaska Cabaret, Hotel, Restaurant, and Retailer Association filed a law suit in the US District Court. On June 10, 2013, the District Court granted the plaintiffs’ summary judgment motion, holding that the DOL exceeded its authority by issuing regulations on tip pooling in restaurants. The District Court stated that the language of the FLSA is clear and unambiguous; it only imposes conditions on employers that take a tip credit. Final implications are still not clear. Employers of non-tip credit states are still advised to act cautiously around tip pools involving back of the house staff.
QUESTION Tips on Tips Tip Reporting and Audits
When declaring tip income, the IRS requires an employee report:
a) At least 8% of the employee’s total sales b) 10% of the employee’s total sales or 100% of credit card tips,
whichever is higher c) 100% of credit card tips plus 10% of the employee’s cash sales d) None of the above
Tips on Tips Tip Reporting and Audits
Tip Reporting - Requirements Employee
Keep a daily record of tips and sales
Employee who receive $20 or more in tips, either directly or indirectly, in a month must report all tips to the employer by no later than the 10th day of the following month. (Employers may require employees to report tips more often.)
Tips on Tips Tip Reporting and Audits
Tip Reporting - Requirements Employer
Collect employee tip reports
Withhold and pay Social security, Medicare and federal income taxes on all employee tips
Employers must match employee’s Social Security and Medicare taxes on all employee tips (NOTE: this is true whether or not the employee reports the tips) When preparing an employee's Form W-2, include wages, tips and other compensation in the box labeled "Wages, tips, other compensation." Include Medicare wages and tips, and social security tips in their respective boxes. When figuring the employer's liability for federal unemployment tax, add the reported tips to the employee's wages.
Allocate tips to any directly tipped employees who reported tips of less than 8% of his or her sales.
File Form 8027 if tipping is customary, food and drink are provided for consumption on premises and the business employs more than 10 employees or the equivalent (more than 80 employee hours per day) on a typical day.
Tips on Tips Tip Reporting and Audits
Tip Reporting - Forms Form Purpose/Requirements
941 Employer’s Quarterly Federal Tax Return (for payroll taxes)
8027
Employer's Annual Information Return of Tip Income and Allocated Tips (employers with 10 or more employees who work 80 hour or more in a typical day)
4137
Social Security and Medicare Tax on Unreported Tip Income (for employees to report and pay uncollected taxes if regular pay was not enough for employer to withhold all the taxes owed, or on allocated tips)
4070 Employee’s Report of Tips to Employer
QUESTION
Tips on Tips Tip Reporting and Audits
TRUE or
FALSE
In a tip income audit, the IRS focuses solely on recovering income tax from employees who underreport
their tip income.
Tips on Tips Tip Reporting and Audits
Tip Audit Facts The IRS has the right to audit at least as far back as three years - further, if the agency believes it's a case of fraud. Some restaurant servers have even been jailed for tax evasion. Courts continue to hold that the IRS may use indirect and aggregate methods for determining underreported tip income in audits where employee tip reporting records are incomplete or in employer-only audits. In an employer-only audit, the determination is made through an observation that the overall rate of tips for a restaurant is not high enough. Audits are made without auditing the employees of the restaurant. Along with requiring employers to pay their share of FICA taxes on underreported tip income, the IRS may also assess penalties to employers equal to the EMPLOYEE portion of FICA taxes.
Tips on Tips Tip Reporting and Audits
Triggering a Tip Audit Red Flags
Percentage of total reported tips relative to total sales is below industry average
Credit card tips reported on form 8027 exceed total tips declared to employer by employees
Percentage of reported cash tips relative to cash sales is significantly lower than that of credit card tips to credit card sales
Tips on Tips Tip Reporting and Audits
Tip Rate Determination/Education Program (TRDEP)
Program Summary
TRDA (Tip Rate Determination Agreement)
• Restaurant specific • IRS works with employer to determine tip rate
for each job classification • Requires at least 75% of employees to sign a
Tipped Employee Participation Agreement (TEPA) and report at or above the determined rate
• Employer provides IRS with name, SS#, sales and tips reported, etc. of employees who do not comply
• Protects employer from prior period audits
Tips on Tips Tip Reporting and Audits
Tip Rate Determination/Education Program (TRDEP)
Program Summary
TRAC (Tip Reporting Alternative Commitment)
• Employer must establish a quarterly education program for existing employees and educate newly hired employees about their tip-reporting responsibilities.
• Employer must file all appropriate returns and make timely tax deposits to be in compliance.
• Employers with more than 10 employees (80 work hours per week) must file Form 8027.
• Adequate records must be maintained and made available to the IRS.
• Complying employers will not be subject to employer-only audits.
Tips on Tips Tip Reporting and Audits
Tip Rate Determination/Education Program (TRDEP)
Program Summary
emTRAC (Employer-Designated TRAC)
• Same requirements and advantages as TRAC • More flexible than a TRAC. • Employer develops and submits for IRS
approval a tip education and reporting program for their employees.
Tips on Tips Best Practices
Problems and Solutions Issue Best Practices
Auto gratuity is common in your business. Reduced FICA tip credit would have a major impact on business.
• Consider reducing use of auto gratuity and printing suggested tip amounts on guest checks
• Retain a portion of the auto gratuity for the house
Employees underreport tips • Strong policy including tip allocation policy • Tip reporting training and education • Tip Agreements (TRDA, TRAC, emTRAC)
Want to include kitchen staff in tip pool • Voluntary tip pool • Service charge instead of tip
Tips on Tips Final Tips
• Know the difference between tips and service charges and maximize the advantages of each
• Structure fair and compliant tip pools and tip sharing agreements
• Understand your tip reporting and withholding responsibilities
• Avoid tip income audits through education and solid employee requirements
LET’S HEAR FROM YOU
Questions?
What are your experiences and best practices?
Tips on Tips
The material appearing in this presentation is for informational purposes only and is not legal or accounting advice. Communication of this information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials may have been prepared by professionals, they should not be used as a substitute for professional services. If legal, accounting, or other professional advice is required, the services of a professional should be sought.