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How Do I Account For Gratuities In My Payroll? [Ask The Experts Q&A]

Sep 13, 2011

Q: We own a small restaurant and I am unsure how to account for tips which the staff declares in the Point of Sales System at the end of the day. 

How do I deal with the tips per pay period? For example, we have two GMs/bartenders who each make $250 a week (no hourly). I have figured out how to deal with payroll taxes on this set amount, but how do I account for the tips that they get on credit cards?


A: Your question is a very good one and one that I personally always thought was cumbersome. The first key point is that tips are taxable income to the employee and should be included on their W-2 at the end of the year. Secondly, the tips are subject to federal income tax withholding and are also subject to FICA, Medicare and FUTA tax withholding. That is the cumbersome part, since much of the tip income is in cash and you may never know about it.

So, the first key point is that the employee is required to report to the company the tips that they receive. The tips that they report are included on IRS Form 4070, Employee’s Report of Tips to Employer. It can be a different form if that is easier; the IRS just gives us this form so that we don’t have to come up with one on our own. The employee is supposed to provide that information to you by the 10th of the following month.

You will then use that report to complete your payroll calculations. You are required to withhold all taxes from those amounts as well, but you don’t have the cash on the front end. You, therefore, simply withhold that amount from their regular check or any other payments that you would normally make to them. If there isn’t enough other money to withhold, then you can just indicate that on the quarterly payroll tax return as an adjustment.

The bottom line is that the tips DO need to go on the payroll tax returns and the W-2 at the end of the year, and are treated just like other income when it comes to withholding, FICA, Medicare, FUTA, etc. The IRS has a good publication to help with the detail called Publication 15, Circular E, Employer’s Tax Guide. You can download the publication for free from the IRS website at . Check out chapter 6, which is exclusively about tips.

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