QuickBooks Small Business

Accounting & Payroll Issues for Restaurant Tips and Service Charges

Written by Stacey Byrne

In part one of this two-part series on restaurant accounting and payroll, I’ll discuss the difference between tips and service charges, tip reporting requirements, and accounting for cash tips, credit card tips and service charges. In part two of this series, I’ll examine the payroll considerations for tips and service charges and how to record payroll from an outside payroll service provider, as well as examine the employer tax credit for tipped employees, including how to calculate and file for this substantial tax credit.

One of the most challenging elements of restaurant accounting is paying and taxing cash and credit card tips. Some of the money is already in the servers’ pockets, and some is in the restaurant’s bank account.

Did you know that the automatic gratuity added to the check for large parties is not actually a tip? The restaurant does not have to give a dime of that money to the server. Or, did you know that the restaurant is entitled to a tax credit on the payroll taxes paid on employee tips? For employees paid $5.15 per hour or more, a 100% annual tax credit is available on the FICA taxes paid by the employer throughout the year.

Tips Versus Service Charges

Many people assume that the automatic gratuity of 18% for a large party is a tip for the server when actually none of this money has to go to the server. Tips and service charges are reported differently on payroll reports and in the restaurant accounting. According to the IRS, in order to determine if a payment is treated as a tip, these four factors must be considered:

  1. The payment must be made free from compulsion;
  2. The customer must have the unrestricted right to determine the amount;
  3. The payment should not be the subject of negotiations or dictated by employer policy; and
  4. Generally, the customer has the right to determine who receives the payment (i.e., the server and anyone the server chooses to or is required to pool or share the tips with).

If these factors do not justify the payment being treated as a tip, it is treated as a service charge.

Payroll Issues

In the example pictured above, the 18% gratuity fails all four of these tests: the customer is compelled to pay an amount negotiated solely by the restaurant, and the customer is not able to choose how much to leave or who receives it. This payment needs to be treated as a service charge. We will discuss the accounting treatment of each scenario later in this article, and the payroll considerations and the effect on the employer tax credit on reported tips in part two.

Tip Reporting Requirements

When employees fail to pay taxes on their tips, the IRS considers this a form of tax evasion. Unreported tips will also cause an employee’s W-2 income to be lower than it actually is. Unreported income becomes a problem when an employee applies for a loan and finds out their income is too low to qualify.

The restaurant is also taking a big risk in the event of an audit. It is easy for an auditor to discover unreported tips if no tips are reported through payroll. It is also a certainty that if an establishment has credit card tips, there were also cash tips. It is important for the restaurant to require employees to report all of their tips or the restaurant runs the risk of incurring additional taxes and penalties for failing to report and tax the tips.

It is the employee’s responsibility to report the amount of cash and credit card tips received to the employer. It is not the employer’s responsibility to keep track of the tips collected by each employee. While the employer may know how much a particular server collected in credit card tips, the employer has no way to know how much cash a server picked up off the tables, nor does the employer know the amount of tips that server shared with the busser or the bartender.

The employee reporting can be accomplished with a form similar to the example shown below.

Form 4070

This exact form does not have to be completed, but the same information needs to be on whatever format you use, including an employee signature. An example is provided by the IRS for the employee to use to keep track of his or her daily totals. The IRS suggests tips be reported at least monthly; however, it is best to get this report on a daily or, at most, weekly basis so you can be sure the employees are providing accurate and timely information.

Accounting for Cash Tips

When a customer leaves a cash tip on the table, the money goes right into the server’s pocket. While these cash tips need to be taxed for payroll purposes, there is no effect on the restaurant accounting. There is no entry to be made whatsoever. We will discuss the payroll treatment of cash tips in part two of this series.

Cash Tips


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About the author

Stacey Byrne

Stacey Byrne (@SLByrneCPA) is a practicing CPA with 25 years' experience consulting with a variety of small to medium-sized businesses including restaurants, construction companies, law firms, and not-for-profit organizations. She is the co-author of Restaurant Accounting with QuickBooks, with Doug Sleeter. Stacey has worked as a staff accountant at the Iacopi, Lenz & Co. CPA firm, and is the former director of finance for a management company where she oversaw accounting and payroll for multiple facilities, including a sports/entertainment arena, theater, ice rink, and ballpark. She is a former adjunct professor of QuickBooks at San Joaquin Delta College in Stockton, California.

Stacey holds several Intuit certifications in QuickBooks (Advanced Desktop, Advanced Online, and Enterprise). She is a certified Sleeter Group QuickBooks consultant and a certified Xero Partner.

Stacey holds a B.S.B.A. degree in Accounting from California State University, Stanislaus, and is currently in pursuit of her M.S. Ed. degree in Online Teaching and Learning at California State University, East Bay. She is also a member of several professional organizations, including the California CPA Society, Sleeter Group Consultants Network, and the Woodard Network.

When she is not writing, working with clients, or studying, you will likely find Stacey at a San Francisco Giants game or enjoying family time with her two sons.

4 Comments

  • Oh wow! I never knew about the gratuity not being a tip! I always thought it went to the server as a tip. Next time I am in a restaurant and I see that a certain percent is charged for a group over X I am going to ask how much of it will go to the server. I don’t like the thought of a server getting no tip, but I also don’t think it is right to leave a tip when a gratuity is added.

    • Thanks for your comment Elizabeth. Knowing whether to tip or not to tip on top of a service charge is perplexing, to say the least. To top it off, a lot of restaurants don’t understand that the service charges are income and (in California) are subject to sales tax. If they DO share the tips with the servers, it has to be treated as regular wages.

      • I remember about 10 years I worked for an accounting firm in the payroll department. One of my clients was a restaurant. I occasionally ran into trouble with servers who made huge tips combined with a small hourly wage. The tips were added into the gross, taxed then deducted after taxes. Occasionally I had to hold over some of the tips to the following payroll because I couldn’t calculate a zero net check. Not sure if that’s the way payroll for restaurants is done now. I guess I will just have to wait for part 2 of this article. 🙂

        • Tax shortfalls are not covered in part two, but you will find other useful information in that article. We don’t see this situation much in California because of the higher minimum wage, but the IRS has guidelines on how to handle this. It can get very complicated. IRS Tax Topic 761 discusses this situation in detail.

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