Restaurant Tip Withholding Requirements, Importance of Proper Reporting & More

Restaurant tips have their share of mystery surrounding them – but they don’t have to! Since tips are an extra type of payment to servers, bartenders, and other restaurant staff, they’re often regarded as under-the-table income.

But that’s the first mistake usually made when calculating tips. Tips are considered taxable income to the recipient, and must be accounted for accordingly.

Plenty of questions pop up about restaurant tips, including:

  • Are tips calculated differently than regular hourly income?
  • Are credit card tips taxed on paychecks?
  • Do employers pay taxes on tips?
  • And many more

RASI, the leader in restaurant accounting software, is here to set the record straight on restaurant tips. Make sure you check out our in-depth article on restaurant tips for helpful info. Let’s get into some specifics to help you fully understand tips!


Requirements for Tip Recipients

Here are the three golden rules for any restaurant employee who receives tips:

  • Keep a running log of all restaurant tips – daily records are recommended.
  • For any month that exceeds $20 in tips, report all cash and credit card tips to restaurant management.
  • Report all tip income (including regular income) to the IRS – this ensures the proper tax amount is withheld.

Withholding & Reporting: Requirements for Employers

Employers also have their share of responsibilities. Do employers pay taxes on tips? What about FICA taxes? To ensure IRS compliant withholding requirements, employers should always track:

  • Cash and credit card tips for all staff.
  • Restaurant tips split between employees – also known as “tip pooling.”
  • Monetary value of all non-cash tips.
  • Withholding income and Federal Insurance Contributions Act (FICA) taxes on all employee wages – regular income and tips.

In order to account for employee income, it helps if your restaurant has a financial reporting system, which is one of RASI’s core offerings.

What Happens If Employee Taxes Aren’t Paid on Restaurant Tips?

For employees, it’s required by law to pay taxes on all types of restaurant tips (credit card, cash, non-monetary tips). Failure to report and pay could result in a penalty equal to 50% of the FICA taxes on unreported tips. There are circumstances with reasonable cause to show why the taxes weren’t reported to the employer, but it’s best to report everything, all the time – this goes back to keeping regular, accurate tip logs.

Consequences of Failing to Report Taxes for Restaurant Tips — Employers

If employers are always properly closing out financial periods – which includes restaurant tips – they can avoid all the headaches involved with non-compliance.

You might be unaware, but every March, large food & beverage establishments are required to report income from the prior year. This includes all food & beverage consumption, tips, and other information. This is called the Employer’s Annual Information Return of Tip Income and Allocated Tips.  

Given the laws and regulations related to restaurant tips, it’s important for employers and employees to pay taxes on all tips, whether cash, credit card, or non-monetary tips (equivalent cash value).

It’s so important, in fact, that a 2002 U.S Supreme Court case, U.S. v. Fior D’Italia, established the guidelines for tip reporting. In this case, the IRS concluded that cash tip income was considerably under-valued than charge tip income. Bottom line: the restaurant in this case was required to pay the difference. The Supreme Court upheld the IRS findings, something now known as the aggregate estimation method.


Sign Up with RASI Today!

That’s why your restaurant should have a compliant, accurate, easy-to-use Payroll Reporting system in place. RASI provides this and much more – don’t take chances with the IRS for under-reporting taxes due on restaurant tips. Request a free demo today, or call our experts directly at (720) 826-9900. Thanks for considering RASI for your total restaurant accounting solutions!