If you are an employer who manages a restaurant, you may have to allocate tips to your employees who receive tip income in some special situations and you should know the methods of tips allocation that you can chose. You can check here our article regarding “Allocated Tips”.
Methods of Allocation
There are 3 methods of tip allocation that you can use:
- the good-faith agreement method,
- the hours-worked method,
- the gross receipts method.
Each method has its own rules and limitations, and you must choose one method for each calendar year. You may allocate the tips for the respective calendar year either annually, by payroll period or by using reasonable divisions of the calendar year, such as quarters, months, semimonthly periods, etc.
Good Faith Agreement Method
The good-faith agreement method allocates tips based on a written agreement between you and at least two-thirds of your tipped employees of each occupational category (for example, waitstaff, bussers, maître d’s). You can use this method only if the agreement meets certain requirements:
1. Allocates the difference between total reported tips and 8% (or the lower rate) of gross receipts among tipped employees in a way that approximately reflects the actual distribution of tip income among employees,
2. Becomes effective on the first day of a payroll period that starts after the agreement’s adoption date, but no later than January 1 of the following year,
3. Has to be adopted when there are tipped employees in each job category who would be impacted by the agreement,
4. Allows for cancellation through a written agreement adopted by at least two-thirds of the tipped employees in occupational categories affected by the agreement. And the cancellation only takes effect at the start of a payroll period.
Hours-Worked Method
If there is no good-faith agreement and your business has less than 25 full-time employees, both tipped and non-tipped, in a payroll period, you can use the hours-worked method to allocate tips. Your business is considered as having less than 25 full-time employees in a payroll period if the average daily hours worked by all employees per business day, tipped and non-tipped, is under 200 hours.
This method has several steps that you need to follow and you can find the details by clicking here. Furthermore, the hours-worked method allocates tips using a fraction where the numerator is the number of hours worked by each directly tipped employee and the denominator is the total number of hours worked by all directly tipped employees in the respective payroll period. You can use this method only if you meet certain conditions, such as having accurate records of hours worked and tips received by each employee, more details can be found here.
Gross Receipts Method For Tips Allocation
If there’s no good-faith agreement for the payroll period, you can calculate the difference between the total reported tips and 8% of gross receipts using this method. This method has several steps that you need to follow and you can find the details by clicking here. But it is important to know that this method allocates tips based on a fraction that has for the numerator the amount of the establishment’s gross receipts attributable to the directly tipped employee and as the denominator the gross receipts attributable to all directly tipped employees.
Moreover, you can check here an example to better understand this method.
In summary, you must report the allocated tips to the IRS and to your employees. File Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, to report the tips received and allocated by your establishment. You must also show the allocated tips on each employee’s Form W-2, Wage and Tax Statement, in box 8 and choose a method of tips allocation. You must check on the W-2 form on line 7a, 7b or 7c the method used. However, you do not withhold income tax or FICA taxes on allocated tips.
Besides, you can check our blogs related to these subjects and find out more here.
In the meantime, if you need accounting and tax services for your business, we are here to help. Click here to schedule an appointment.
This material is for informational purposes only. It does not constitute tax, legal or accounting advice.