If you own or manage a food or beverage business, your employees probably receive tips from your customers as part of their income. They can receive tips from customers who pay by credit card, debit card, cash or even gift cards and other non cash tips. Employees must report tips as taxable income to both the IRS and their employer. However, you may also have to allocate tips to your employees in some situations.
About Allocated Tips
These tips are additional tips that an employer allocates to employees on top of the tips that the employees have already reported to the employer. This happens only in certain conditions:
- the employees work in a large food or beverage establishment, like a restaurant, cocktail lounge (to see the definition of a large establishment) and
- the total tips that all employees reported to the employer were less than 8% of the total establishment’s sales of food and drinks.
In simpler terms, if you own a tip-based establishment, like a restaurant, and the total tips reported by all employees are less than 8% of the total food and drink sales they served, you, as an employer will allocate additional tips among all employees who received tips to make up for that difference. These additional tips are called “allocated tips”.
How To Report These Tips?
When an employer allocates extra tips to an employee, the employer reports these tips separately in box 8 of Form W-2. The employer does not include these allocated tips in box 1, where the employer reports wages. Therefore, if box 8 of Form W-2 is empty, it indicates that the employer did not allocate any extra tips.
As an employer, you can use Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, to calculate and report allocated tips for your establishment. You must file this form by the last day of February of the following year.
The purpose of allocating tips is to ensure that your employees report their tip income correctly to the IRS and pay their fair share of taxes. However, allocated tips are not considered wages for FICA tax purposes, since the employee did not report the amount to the employer, so you do not need to withhold or pay any Social Security or Medicare taxes on them and you do not report them in boxes 5 and 7 of Form W-2. You also do not need to include allocated tips in the regular rate of pay for calculating overtime pay.
If your employees disagree with the amount of tips you allocated to them, they can request a correction from you. They can also show a different amount of allocated tips , if they have adequate records, when filling Form 4137, Social Security and Medicare Tax on Unreported Tip Income, with their tax return.
You can find out more details regarding “Tips Reporting for Restaurants” here.
Lower Rate
If an employer wants to calculate allocated tips using a tip rate less than 8% (but not less than 2%), the employer needs approval from the IRS. Either the employer or a majority of the employees can ask the IRS for this approval. You can request the lower rate by filing a petition that includes specific information about the establishment to justify this lower rate. For details on how to file this petition, refer to the instructions for Form 8027, which is the Employer’s Annual Information Return of Tip Income and Allocated Tips.
Allocated tips are a complex and often a confusing topic for employers and employees alike. If you have any questions or doubts about how to handle them, you should consult a tax professional or the IRS for guidance.
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This material is for informational purposes only. It does not constitute tax, legal or accounting advice.