Many businesses with employees who receive tips are not aware of what is a tip versus what is a wage.
The IRS defines service charges or automatic gratuities that a business imposes on its customers, as taxable wages when paid to an employee. This includes if the business imposes an automatic tip amount on large parties or a flat charge related to a function or banquet fee. Service charges are taxable wages, and subject to withholding and employer taxes. Only the amount paid to the employee is a wage. If the business keeps a portion, that amount is not a wage to the employee because they did not receive it.
- An automatic tip percentage on large parties
- A function or event fee
- Service charges for a hotel room
- Other fees
In contrast, a tip includes cash tips, an electronic tip, noncash tips like tickets and other tips received from tip sharing. There are four factors used to determine whether a payment qualifies as a tip:
- The payment must be made free from compulsion
- The customer determines the amount
- It is not subject to negotiation or indicated by an employer policy and
- The customer determines whom receives the tip
Remember, all tips must still be reported to the employer and included in the employees’ gross wages and subject to federal income taxes.
If you are unclear about what should be reported, please contact your payroll service provider or your accountant.