In many occupations, employees are given tips in addition to or in lieu of an hourly wage. Since the tips come from numerous individuals and generally are in the form of cash, the question of how the IRS deals with tips comes up frequently.
Tips and Withholding
Employers are responsible for withholding Social Security, Medicare and federal taxes from an employee's tip income. When a customer adds the tip to a credit card, this is easy to keep track of and account for. But when the tip is in cash, the employer has to rely on the honesty of the employee.
Form 4070-A is used to keep a daily tally of an employee's tips in cash and credit. The amounts are calculated and added to Form 4070, a monthly report sent to the IRS with the employee's name, address and Social Security number. The employer's name, the period the form covers and the amount of tips are also included.
Collecting the Federal Tax
Employers may collect the federal taxes owed on tips from the state-mandated minimum wages or from amounts reported by the employees themselves. Employers also may pay taxes out of pocket as an expense of doing business. The bottom line is that the employers are responsible for the collection, reporting and payment of these taxes.
Minimums and Allocations
The IRS requires that the amount of tips claimed during any period be at least 8 percent of the total receipts earned for that period. When the amount is less than 8 percent, the employer has the option of allocating the difference between 8 percent of total receipts and what was reported. Details on these allocations can be found in the instructions for Form 8027.
Employers who are considered to be large food or beverage establishments are required to file the annual Form 8027. This form includes the total amount of tip income for the establishment for the year. It ensures that the amount of tips claimed is at least the 8 percent minimum.