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:
- 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 (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.
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.
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.