Service Charges? Tips? Who knows the difference? Who needs to know about them? Can we just lump tips and service charges all together for taxes?
In our previous blog, we focused your tax duties if you were an employee who received tips from customers. In this blog we will turn the tables, so to speak, and discuss some of the duties and tax issues of you as an employer.
And no, the tax code does not allow you to lump service charges and tips together. Absolutely not!
You value your employees and we would assume you want to do well by them. We have heard it said that the best way to build a business is to hire and keep the most qualified people. You have hired them, and so you owe it to them as well as yourself to scrupulously follow the IRS rules for tips, service charges and taxes. It’s a way of cherishing them that is neither mushy or mysterious; it’s just the right thing to do.
The Business Owner’s First Rule of Distributed Service Charges
Service charges distributed to employees “must be treated as wages to those employees.” Yes, as the employer, you must keep a record of:
- When You Charge a Service Charge: You must report the name of your cherished employee, his or her address, and his or her social security number,
- Plus you must list: the amount and date of each payment.
- Likewise, delineate:“the amount of income, social security, and Medicare taxes collected with respect to the payment.”
- Be meticulous, not only out of respect to your fine employees and your business, but because in an examination, the IRS might ask questions. They might want you to show just exactly how you differentiate sales subject-to -service-charges from those sales-subject-to-tipping.
Powerful Tax Examiner’s Questions about Your Sales, Service Charges, and Tips
- Never forget the value of the daily receipts. (We have seen their importance to the law demonstrated time after time by popular Law and Order television shows! As they are important in the law, they are equally important in validating your business practices.) You see, examiners might study random samples of daily receipts.
- Ultimately, examiners could ask you for a little tour from the POS (Point of Sales) through a complete transaction. They want to trace it from the “customer’s bill, to the POS transaction or sales journal…”to the employee’s paycheck.
- That’s right, You, as an employer must be able to trace the service charge or tip to payroll “to validate how the distributed service charges were paid out to the employee.”
- Like we first stated, there is no legal doubt that a service charge goes to the employer, not the employee, in the eyes of the IRS. Later you might choose to share that service charge, but it is still part of your income. See more on this, below.
About Those Service Charges…
“Service charges retained by the employer are income to the employer.” Tax examiners might request Point of Sale (POS) records, such as summary reports regarding sales transactions. This can get very deep into your records.
Of course if you are utilizing a cloud-based technology such as GUSTO, your sales and payroll details will be crystal clear. Check with your Gavrilov & Co. Tax Squad to see if there are advantages in this software for your business.
- Never forget the value of the daily receipts. (We have seen their importance to the law demonstrated time after time by popular Law and Order television shows! As they are important in the law, they are equally important in validating your business practices.) You see, examiners might study random samples of daily receipts.
- Ultimately, examiners could ask you for a little tour from the POS through a complete transaction. They want to trace it from the POS transaction or sales journal to the employee’s payroll…” But that is not all! You, as business owner must be able to trace the service charge or tip to payroll “to validate how the distributed service charges were paid out to the employee.” Like we first stated, there is no legal doubt that a service charge goes to you, not the employee.
According to the IRS, “Service charges retained by the employer are income to the employer.”
Definitions: Service Charges Vs. Tips
Of course if you are utilizing a cloud-based technology such as GUSTO, your sales and payroll details will be crystal clear. Check with your Gavrilov & Co. Tax Squad to see if there are advantages in this software for your business. Let’s square up some basic definitions:
On the one hand, “Service charges are fees imposed upon customers by the employer. Thus, service charges are always income to the employer regardless of whether the employer distributes all or a portion of the service charges to employees.”
On the other hand, “This is distinguished from “tips” which are voluntarily paid by customers to employees. Tips are not gross income to the employer.”
A Business Owner’s Options: Service Charges
As business owner, once you collect service charges, you might keep all or part of the money so received. As we have said, you must realize that whether you distribute part of these charges to employees or not, you must count it as gross income.
Cheer up, however, there might be a reward for your generosity if you share them with employees. You might be entitled to business deductions if you meet the usual criteria for a business deduction, as stated in section 162 of the Internal Revenue Code.
Mystery Number 2: Solving One More Mystery–What About Those Tip Calculations?
As we said, this blog only identifies a few of the issues with tax, service charges and tips, and there are many. That being said, let’s look at one more common mystery.
We have all seen sample tip calculations given on a bill we receive after we eat at a restaurant. These suggested tipping amounts are legal and validated by the Revenue Ruling 2012-18.
Let’s summarize the moment. You just had a great dinner, and you peruse your ticket. You see sample calculations of tip amounts beneath the signature line on the restaurant’s bill. Then you see an actual tip line and it has been left blank, just for the customer to fill in.
Likewise you see sample tip calculations of 15%, 18% and 20% of the price of food and beverages. You choose 18% and arrive at a total. Now, you could have entered any amount you wished. Neither the wait-person nor the restaurant specified that you needed to pay that percentage. That’s a tip, and in no way a service charge, simply because the amount was not mandated. (The calculations are just suggestions, put together as a courtesy. They save you from doing after-dinner math.)
Mystery Number 3: Voluntary Tip Compliance Agreements
The IRS established Voluntary Tip Compliance Agreements expressly for industries where tipping is customary.Lawmakers designed these agreements are designed to encourage your employees to honestly report their tips.
Likewise the agreements were developed with employers in mind. The idea behind the voluntary tip compliance agreements was to encourage tax compliance with education instead of enforcement techniques like tip examinations.
“In addition to helping taxpayers understand and meet their tip reporting responsibilities, these agreements offer many benefits for the employer and the employee.” Here are the current types of voluntary tip compliance agreements, offered to you as employer:
TRAC – Tip Reporting Alternative Commitment
TRDA – Tip Rate Determination Agreement
GITCA – Gaming Industry Tip Compliance Agreement
Check out more information about these agreements at the IRS online resource, the Market Segment Understandings program. See why the IRS has voluntary tip compliance agreements available for industries where tipping is customary.
Mystery Number 4: Let’s Demystify Form 8027–A Special Form for Employers Who Operate Large Food or Beverage Establishments
If you operates a “large food or beverage establishment,” the IRS hasa very special form for you. You must complete Form 8027. https://www.irs.gov/pub/irs-pdf/i8027.pdf
Fear it not if you keep good records and employ honest people. Form 8027, the Employer’s Annual Information Return of Tip Income and Allocated Tips,is simply an annual report to the IRS. It validates tips employees reported to the employer.
Likewise you can use Form 8027 to determine allocated tips for tipped employees. And keep in mind that file a Form 8027 for each large food or beverage establishment. Thus, we see many employers and business owners who are required to file multiple Forms 8027. https://www.irs.gov/pub/irs-pdf/i8027.pdf
The IRS will term your food or beverage operation as a large one if you fit all of the below qualifications:
- “Food or beverage operation is located in the 50 states or in the District of Columbia.” (Of course.)
- “Food or beverages are provided for consumption on the premises (other than fast food operations).
- Tipping of food or beverage employees by customers is a customary practice.
- Employer normally employed more than 10 employees on a typical business day during the preceding calendar year.
Mystery Number 5: About Allocating Tips
Now, Gavrilov & Co wants you to understand: “If your employees report less than 8 percent of
the gross receipts (or a lower rate approved by the IRS), the employer must allocate the difference among the employees who receive tips.”
In summary, we have made two big points here:
1. If you are a large food or beverage operation, you will compute and report receipts and tips on the Form 8027.
2. Likewise you will compute and report the “allocated tips.” Use Form 8027, the “Employer’s Annual Information Return of Tip Income and Allocated Tips.”
One Last, Important Point…and a Wish
Then, as the employer, you will show the allocated tips on the employee’s Form W-2, Wage and Tax Statement, in the box conveniently entitled “Allocated tips.”
We see no mystery in that, but remember with your 8027, no income tax, social security or Medicare taxes are withheld on allocated tips.
We would be remiss if we did not note that Gavrilov & Company wishes you, your family and your business, the happiest of Holidays during this warm and wonderful season.