17 Jul Prudent Tips on Employee Tip Withholding
If your employees regularly receive tips, it is important to comply with the withholding requirements and pay your company’s fair share of employment taxes. Expensive penalties can be assessed on both employers and employees if the tip reporting rules are not followed.
Here’s a brief summary of some of the requirements for federal income tax and FICA (Social Security and Medicare) withholding, as well as filing.
Income Tax Withholding
You’re required to withhold federal income tax on an employee’s cash tips of $20 or more per month. The employee is generally supposed to report the tips to you by the tenth day of the month following the month of receipt.
Your company can elect to treat tips as supplemental wages. The tips can be reported in the regular payroll amount or subject to withholding at a flat rate of 22%.
If the employee’s cash tips do not exceed $20 in a calendar quarter, there is no FICA tax liability. However, any excess is subject to FICA. The same general rules apply to tips as wages. For instance, the Social Security portion of the tax applies to an annual “wage base” of $132,900 in 2019 (up from $128,400 for 2018). The 1.45% Medicare portion of the tax applies to all wages. Once earned income reaches $200,000 (or $250,000 for married couples) 2.9% rises to 3.8%, without limit.
The employee’s share of Social Security tax is 6.2% and the Medicare portion is 1.45%. Employers do not pay the additional Medicare tax.
If you run a food or beverage establishment, you may be able to defray part of the cost of FICA through a special tax credit. Ask your payroll tax adviser if you are eligible for the 45B Credit, named for the section of the tax code it comes from.
Note: Reported tips are also subject to federal unemployment tax (FUTA). There are no income limits.
These withholding rules require the employer to collect income tax and FICA on reported tips unless the employee provides the necessary funds. If you can’t deduct the full amount from the employee’s regular wages — and the employee doesn’t otherwise provide the funds — the tax must be paid directly with the employee’s tax return. If you can collect only part of the amount due, apply what you collected first to FICA.
A business is generally required to file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, for each establishment if:
- Food or beverage is provided for consumption on the premises.
- Tipping is a customary practice.
- More than 10 full-time employees are employed on a typical business day.
The term “employee” isn’t limited to waiters and waitresses. It comprises everyone on the payroll, from cooks to dishwashers to musicians.
Caution: Employees who don’t follow these tip reporting rules may be hit with a penalty equal to 50% of the FICA tax due in addition to paying the employer’s share of the tax.
Tell Employees Why They Should Report Tips
The IRS provides the following points employers can make to employees who are reluctant to report their full amount of tips.
In the long run, it’s beneficial to report all tips because:
1. Tip reporting increases Social Security credits, which maximizes benefits at retirement.
2. It can make the employees eligible for higher amounts of unemployment benefits and Workers’ Compensation.
3. It may increase the chance of receiving financing for a home, car or other necessities.
Payroll Partners is committed to helping clients stay informed about payroll and human resource news. This article is intended to provide readers with general information on human resources matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular practice. All efforts have been made to assure the accuracy of the information. Payroll Partners does not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular practice. If you are seeking human resources advice, you are encouraged to consult a human resources professional.