At this middle point of the year, it is extremely important to analyze where you stand with your employee tip reporting. Following IRS standards, all tips received by employees should be reported through payroll. Any deviation from actual tips received and tips reported will cause a payroll tax liability. The IRS rarely goes after individual employees for their portion of the payroll taxes on unreported tips, but instead is satisfied going after the employer for the 50% of the total payroll taxes owed.

Audit activity shows that the IRS is auditing when a total tip percentage falls below 12%. Because the filing of tip reporting (IRS 8027 filing) is done in February, audits in the restaurant segment are especially problematic. If you fall below 10% on your filing, you will automatically need to go back and allocate tips to your employees. Unfortunately, by the end of February many employees have already filed their taxes, so they will be required to refile their taxes to include the additional allocation of tip income. Allocating tips almost always creates an audit.

A simple analysis will show whether your tip reporting is in line with the final analysis that will be done by the IRS. Simply calculate the following through the end of June; your total sales (net), total credit card sales (including tips), the total credit card tips, and total declared tips reported. These four data points will allow you to calculate the average tip percentage received by your employee group. Using this number and extending it to all sales with allow you to include the cash tips received and produce an overall tip percentage. See example below:

A) Total sales through June 2016 $4,669,540
B) Credit Card Sales through June 2016 $4,090,843 (87.6% sales are credit card sales)
C) Cash Sales through June 2016 $578,697 (12.4% cash sales)
D) Total Tip Amount on Credit Cards $790,266
E) Declared Tips through June 2016 $580,943
F) Total Tip Percentage on CC Sales 19.4% D/B
G) Reported Tip percentage on CC Sales 14.2% E/B
H) Reported Tip percentage of Total Sales 12.5% E/A

A mid-year analysis will allow you to identify problems and enforce declaration of tips by your employee group, which will put you in a good position by the end of the year to avoid allocation or an audit. Having a tip declaration policy and procedure in your employee manual allows you to discipline employees who are not declaring properly. Many restaurants have changed their policies to automatically push credit card tips through payroll to ensure compliance on that income, which is highly recommended as it lessens the employer liability significantly.

Please contact us if you need assistance with analysis, policy guidelines or recommendations for alternative tip policies.

About the Author

Jean Hagan, PrincipalJean Hagan - Los Angeles CPA
Restaurant, Hospitality
Jean has owned, operated, and consulted in the restaurant industry for more than 30 years. During that time, she worked with a well-known national chain; owned a food and beverage company that operated multiple restaurants, bars, and event spaces in the Squaw Valley area; and became the president, CEO, CFO, and shareholder of one of the highest-grossing restaurants in California. Today, Jean is Principal and leads the Restaurant Operations Consulting practice at KROST. » Full Bio