Although tips are paid directly to wait staff by customers, they are still subject to taxes. The IRS sees this money as income even when it is paid in cash and even though it is not part of employee paychecks. Although the IRS wants a cut of tip revenue, this money does not actually count as restaurant revenue. Restaurants are supposed to withhold taxes on tip income, but this income counts as earnings for the wait staff rather than for the restaurant.
To withhold income tax on tip income, you must know how much your employees earned. The IRS requires wait staff to report monthly tip income to employers on the tenth day of the month following the month when the tip income was earned. Employees must complete IRS Form 4070 monthly for all tip income unless they earned less than $20 during the monthly reporting period.
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Employers must add reported employee tip amounts into the totals of taxable income that they use as the basis for calculating income tax, Social Security and Medicare withholdings. Restaurants with more than 10 employees must also file IRS Form 8027 annually. This form provides a record of the total amount of tip income the restaurant's employees earned during the year.
Credit Card Tips
Most restaurants offers customers the option of including tip amounts in credit card transactions. Tip amounts entered on credit card receipts provide a verifiable paper trail of tip income. Even though restaurants collect these sums from customers and distribute them to employees, this money does not count as restaurant revenue. It is not included in a profit and loss statement, and the restaurant does not accrue any income or revenue tax because of this money.
The IRS has a verification and withholding system in place to make sure your restaurant reports enough employee tip income and collects enough tax on that income. If the taxes your employees report do not add up to eight percent of your restaurant's income, you must withhold the difference between the reported amount and the required eight percent. In other words, you must collect tax from your employees on tip income equaling at least eight percent of the restaurant's gross sales whether or not they have actually reported this amount of tip income.