Reporting Tips of Directly- and Indirectly-Tipped Employees
Employees must report to their employer all cash tips received — except for the tips from any month that total less than $20:
- Cash tips include tips received from customers, charged tips (for example, credit and debit card charges) distributed to the employee by his or her employer, and tips received from other employees under any tip-sharing arrangement.
- Noncash tips (that is, tips received by an employee in any other medium than cash, such as passes, tickets, or other goods or commodities) from customers are not reported to the employer.
All cash tips and noncash tips should be included in an employee’s gross income and are subject to federal income taxes.
Both directly- and indirectly-tipped employees must report tips to their employer.
A “directly-tipped employee” is any employee who receives tips directly from customers, including one who, after receiving the tips, turns all of them over to a tip pool. Examples of directly tipped employees are waiters, waitresses, bartenders, cosmetologists and hairstylists.
An “indirectly-tipped employee” is a tipped employee who does not normally receive tips directly from customers. Examples of indirectly tipped employees are bussers, service bartenders, cooks and salon shampooers.
Key Differences Between Categories Affect Both Employees and Tax Reporting
The Internal Revenue Service reminds employers that so-called “automatic gratuities” and any amount imposed on the customer by the employer are service charges, NOT tips.
Service charges are generally wages, and they are reported to the employee and the IRS in a manner similar to other wages. On the other hand, special rules apply to both employers and employees for reporting tips. Employers should make sure they know the difference and how they report each to the IRS.
What are tips?
Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers. Tips include:
- Cash tips received directly from customers.
- Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
- The value of any noncash tips, such as tickets, or other items of value.
- Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangements.
Four factors are used to determine whether a payment qualifies as a tip. Normally, all four must apply. To be a tip:
- The payment must be made free from compulsion;
- The customer must have the unrestricted right to determine the amount;
- The payment should not be the subject of negotiations or dictated by employer policy; and
- Generally, the customer has the right to determine who receives the payment.
If any one of these doesn’t apply, the payment is likely a service charge.
What are service charges?
Amounts an employer requires a customer to pay are service charges. This is true even if the employer or employee calls the payment a tip or gratuity.
Examples of service charges commonly added to a customer’s check include:
- Large dining party automatic gratuity
- Banquet event fee
- Cruise trip package fee
- Hotel room service charge
- Bottle service charge (nightclubs, restaurants)
Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages to those employees.