This case study focuses on an issue that many restaurateurs battle with constantly: TIPS! Controlling the declaration of income from tips by employees has become a challenge for many restaurant operators. There is no question that the IRS demands employers to be the guardians of this and many operators are unaware that they have been placed in that position. The filing of an annual 8027 form with the IRS is mandatory for almost all sit-down restaurant operators. Failure to meet acceptable levels of declared credit card and cash tips places the employer in a position to pay additional taxes and penalties on behalf of the undeclared tips by the employees.

Employers should set up a mandatory procedure for their employees, that require monitoring and disciplinary action for failure to accurately declare and record their tip income. In this particular case, the employer was allocating tips for their employees based on the eight (8%) percent rule and therefore coming under constant auditing by the IRS. Allocating tips no longer accurately represents the number of tips that should be declared as this is based on the credit card sales and recorded credit card tips received by an operation. The IRS calculates the cash tips to be within two (2%) percent of the credit card tips with a buffer for “walkouts” calculated.

We assisted the client in setting up a tip reporting procedure for their entire company which encompassed several units. As part of the rollout, we met with tipped employees and distributed and reviewed specific IRS materials related to tips and tip declaration. We provided employees with a system for recording their tips and tip outs to indirectly tipped employees. In addition, we met with management to assist them on an easy and effective way to monitor tip percentages on a payroll to payroll basis for disciplinary action.

As a result of these actions, we were successful in raising the tip amount reported to the IRS to an acceptable level as it relates to their credit card sales and tips. In addition, the client has not had an audit performed since the rollout of this program.

2010 Tips
Credit Card Sales Credit Card Tips Allocated Tips % TS*
Location #1 $2,967,520 $412,297
Location #2 $3,694,586 $490,605
Location #3 $1,681,288 $204,775


2011 Tips
Credit Card Sales Credit Card Tips Reported Tips % TS*
Location #1 $3,093,222 $391,890
Location #2 $3,973,529 $515,369
Location #3 $1,845,448 $221,651

* TS represents of Total Sales

About the Author

Jean Hagan, PrincipalJean Hagan
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