Here at BenefitMall, we firmly believe that payroll for the average small business should not take more than a few minutes each week. That is why we offer a specialized payroll solution for the restaurant industry. Through years of serving small businesses, we have discovered that payroll for restaurants is a lot more complicated than it needs to be. The complications can be encapsulated in a single word: tips.
Tips are a vital source of income for restaurant servers. In fact, tips are so ingrained in the restaurant industry that patrons think nothing of leaving them. We all just expect to tip our servers as part of the price of dining out. The problem with tips is how they are collected and reported. Believe it or not, every tip you leave does not necessarily go directly to your server.
Tips vs Service Charges
The problem with tips is rooted in the IRS definitions of both tips and service charges. In simple terms, tips are not always considered tip income for IRS purposes. If you visit a restaurant that mandates a certain gratuity for parties of a certain size, let us say 20% for parties of six or more, that restaurant is essentially requiring you to pay that amount. The IRS considers this a service charge rather than a tip.
According to the IRS, tips must meet the following criteria to be considered as such:
- They must be received directly from customers;
- They must not be compulsory;
- The customer must have the unrestricted right to determine the value of a tip and who gets it; and
- Tips must not be subject to negotiations dictated by the employer.
According to the IRS, service charges are defined as follows:
- Gratuities automatically applied to large parties;
- Banquet event fees;
- Package fees on cruises;
- Hotel service charges; and
- Bottle service charges.
Tip Reporting and Distribution
The IRS requires employees to report all tip income except in months when said income does not exceed $20 in total. Otherwise, employees must report both direct and indirect tips. This is where much of the confusion comes into play.
Direct tips are tips that are received directly from customers, whether they pay cash or by credit or debit card. Indirect tips are those paid by employers as part of weekly pay.
When service charges are in play, whatever amount the employer decides to pass on to employees is distributed among them in whatever way the employer sees fit. The employer must report those monies as regular income in combination with hourly wages.
At this point, the difference between tips and service charges does not appear to be exceptionally complicated. However, employees who receive direct tips are required to provide their employees with tip reports, unless the employer does not allow for the receipt of direct tips. Any submitted tip reports have to agree with the income reports the employer files with the IRS and Social Security Administration. If the numbers do not agree, employees W-2 could be wrong at the end of the tax year.
In addition to the W-2 issue, direct tips received by servers have no bearing on the employer's business accounting. Yet some employers make the mistake of recording direct tip income as restaurant income, thereby creating errors in their daily and monthly account reconciliation.
As you can see, tip income can create problems for restaurants. We have created a specialized solution that makes payroll for restaurants as efficient and uncomplicated as possible. If you are finding payroll challenging for your restaurant, give us a call.