If you work in the foodservice industry or receive tips from customers, you’re most likely familiar with reported, unreported, and allocated tips.
As a brief refresher, reported tips are earned directly from customers through credit card charges or cash payments and reported to the employer. These tips are easy to track if paid via credit card because they are automatically documented on the customer’s receipt.
Unreported tips are often seen in the form of cash. Since there is no receipt record of cash tip transactions, they can easily go unreported. It’s the employee’s responsibility to make sure these tips do not go unreported.
Employees receive allocated tips from their employers if the business gets less than 8 percent of gross sales from tips. If a server or bartender, for example, doesn’t receive a normal amount of tips during a given shift, allocated tips are a way for employers to cover the difference and prevent staff from receiving large dips in their income.
Tip allocation is the process of dividing up a portion of profits for allocated tips between staff members. This is calculated in one of three ways:
Businesses can use this method with less than 25 full-time employees. Employers calculate the percentage of hours worked by an employee in relation to the total hours worked by all employees. Tips are allocated to each individual based on this percentage.
Allocated tips can also be determined based on the percentage of gross receipts from each employee compared to the total receipts from the staff or business as a whole. This method is the most accurate.
An agreement based on good-faith can also be established. In this situation, the employer develops a standard system for allocated tips. This method is quick and easy as it doesn’t require a significant amount of time to be spent calculating gross profits or percentages of working hours.
Servers must report all cash tips. This isn’t merely a rule set by the employer, but a mandate by the IRS. All tips are required to be reported on a tax return, which includes cash tips. The only exception to this rule is when cash tips earned for an entire month are less than $20.
Failure to report cash tips will result in penalties from the IRS. “The penalty amounts to half of the Social Security and Medicare tax that would have been due if the tips had been reported,” states the IRS.
The IRS requires you to claim all tips that you receive. This includes tips from customers, the employer, and shared arrangements. Regardless of how tips are earned, the total is considered taxable income and must be claimed. The only exception as mentioned above is a cash tip sum less than $20 for a given month.
Cash tips are subject to Federal income taxes just like non-cash tips. They must be reported for Social Security and Medicare tax deductions.
Allocated tips are assigned to you by your employer in addition to the tips you report to your employer. Simply put, reported tips are tips directly received from customers that you report to an employer. Allocated tips are given to you by the employer. Therefore, he or she already has a financial record.