Restaurant payroll can be complicated if your employees earn more than $30 a month in tips because they’re subject to additional tax laws and regulations. Federal law allows you to pay them as little as $2.13 an hour, dictates what you can deduct from their paychecks, and determines the taxes your business must pay.
Paying taxes on your employees’ tips can be a challenge if they’re tracked manually. Starting at $45 a month, Gusto offers an electronic cash and paycheck tip reporting feature that automatically deducts taxes when you pay regular wages, saving you and your employees time. It’s usually more accurate than using pen-and-paper and can save money by eliminating penalties and fees. Try it free for 30 days.
How Restaurant Payroll Works
Processing payroll for restaurant employees can be confusing if you don’t know the caveats. Tipped employees are workers who earn more than $30 per month in tips, and many states allow you to pay them as little as $2.13 per hour if they earn enough tips to ensure you comply with applicable minimum wage laws. Employees who earn more than $20 a month in tips must report tips accurately and timely, or you could receive an unexpected tax bill in the future.
You are also responsible for clarifying to your new hires how much you’ll be paying in wages and if there are any special required tip programs like tip pooling or sharing. If you require tipped employees to share tips with back-of-the-house employees, be prepared to pay the full minimum wage amount, instead of the discounted rate. Either way, you must withhold and pay taxes on all tips received and be mindful of what can and can’t be deducted from payroll.
To eliminate confusion, you should reference the United States Department of Labor (DOL) website. Even more often, check your state DOL website for updates; some states are subject to change their payroll laws more than others.
Once you understand the requirements of the restaurant payroll, you may still want to utilize payroll software to help improve your tip reporting process. If payroll software doesn’t provide enough support, consider professional employer organizations (PEOs) like Justworks that will stay abreast of applicable federal and state laws, so you don’t have to.
Who Needs to Learn Restaurant Payroll
Learning the ins and outs of restaurant payroll is essential if you pay restaurant employees. Even if you outsource to a restaurant payroll service provider, it’s a good idea to have at least a basic understanding of what your business is responsible for, so you can question anything that doesn’t make sense.
Learning the rules and regulations surrounding industry-specific payroll for restaurants is important for:
- Restaurant owners
- Payroll administrators of a restaurant
- Human resource professionals of a restaurant
- Tipped employees of a restaurant
- Nontipped employees of a restaurant
When it comes to restaurant payroll, it’s important that all restaurant staff are aware of the payroll laws governing the industry. Employers and their human resource (HR) team should be more knowledgeable so that they can educate employees on their rights and responsibilities. Having a more knowledgeable workforce means your business will be prepared in the event of an IRS audit.
Minimum Wage
Since federal and state laws generally have different minimum wage rates for restaurant employees, they’re a good starting point for determining how you will structure payroll for your restaurant. Restaurant profit margins can be low, so estimating your payroll expenses beforehand is essential.
By definition, the minimum wage is the lowest wage an employer can legally pay an employee. The federal minimum wage is $7.25 per hour, so you should always use that as a base when setting pay rates. Also, consider the state you’re in. There are 29 states and one territory (Washington D.C.) with minimum wage rates that are higher than the federal rate.
The National Conference of State Legislatures includes a nice breakdown of all state minimum wages as of January 1, 2019. It also provides detail on rates that states are phasing in future years. For example, if your restaurant is in New York state, and you have 10 employees or less, you must pay your employees $11.10 per hour as of December 31, 2018, and prepare to pay a minimum of $11.80 per hour beginning December 31, 2019.
You should also verify that your local minimum wage laws don’t deviate from federal or state laws. While it’s unusual for most localities, there are some, like New York City and urban counties in Oregon, that set their own minimum wage rates. Remember, when reviewing different wage laws you must comply with the one that requires you to pay the most. If you’re in New York City and you have 11 or more employees, you should be paying a minimum of $15 per hour.
Tipped Minimum Wage
Tipped employees are any workers who regularly receive more than $30 per month in tips above their base pay. These are typically your servers and bartenders. You can use your employees’ tips to help offset the hourly minimum wage you’re required to pay.
Under federal law, you can apply a tip credit of up to $5.12 against the federal minimum wage rate to determine your tipped employees’ pay rates. This means you must pay at least $2.13 per hour ($7.25 federal minimum wage – $5.12 federal tip credit allowance = $2.13 tipped minimum wage), but only if the tips employees earn in a workweek combined with the wage you pay them is at least the minimum wage. If not, you will have to pay additional money to supplement.
Of course, tipped minimum wage rates can vary by state and city. For instance, in Illinois the tipped minimum wage rate is $4.95; and in most of New York state, it’s $7.50 for foodservice workers and $9.25 for tipped service employees. In New York City, it depends on how many employees you have. If you have 10 or under, it’s $9 per hour. However, any more than that and you must pay at least $10.
Even still, some states like California, Nevada, and Oregon don’t allow tip credits. This means you have to abide by regular federal, state, and local minimum wage laws, whichever is higher. There is no tipped minimum wage.
Find your state on the map below to see if it has its own tipped minimum wage:
Notice for Tip Credit
It’s important to note that before you can apply a tip credit to your employees’ wages, you must provide notice, either written or oral, to your employees in advance. We recommend giving written notice and requiring the employee’s signature to confirm they received a copy. It’s best to do this during onboarding.
Per federal law, the notice must contain the following:
- The amount of cash wage you are paying a tipped employee, which must be at least $2.13 per hour
- The additional amount you’re claiming as a tip credit, which cannot exceed $5.12, which is the difference between the minimum required cash wage of $2.13 and the current federal minimum wage of $7.25
- That the tip credit you claim cannot exceed the number of tips received by the tipped employee
- That all tips received by the tipped employee are to be retained by the employee except for a valid tip pooling arrangement limited to employees who customarily and regularly receive tips, meaning no line cooks or hostesses
- That the tip credit will not apply to any tipped employee unless the employee has been informed of these tip credit provisions
To reiterate, you cannot take your employees’ tips, unless they request that you collect for verification purposes. Even then, you must return them.
Some of the best payroll software like Gusto will create an electronic, customizable offer letter your employee can digitally sign and return. If you choose to process your own payroll without software, it’s a good idea to create your own job offer letter with all of the details, hire confirmation, hourly or salary pay rate, company name, new hire name, and so on.
Types of Tips
Tips come in many forms. They can be paid in cash or using credit and debit cards. Automatic gratuities are added on to the bill and are usually called service charges. A pooled tip arrangement is an agreement between a group of employees that decide to add their tips together and divide them among one another at the end of the day. They can determine how they want to divide them unless you have a policy in place.
Tips Received Via Credit Cards
More customers are paying with credit and debit cards than ever before, so it shouldn’t be a surprise that many tipped workers are paid this way. One of the challenges you may face is paying the fee that credit card companies charge to process each sale. Federal law allows you to deduct the percentage from the total tip the employee is due as long as the charge doesn’t reduce the employee’s wage below the required minimum wage.
Example:
A customer adds a $5 tip to her bill to be processed by credit card. Your credit card company charges 5% on all credit sales. You may deduct 25 cents from your employee’s tip ($5 x 5% = 25 cents) to cover the charge, leaving him or her with $4.75 ($5 – 25 cents = $4.75). For all tips received via credit card, you must pay out by the next payday.
If we presented this example from the perspective of an employer in California, the deduction would be nonexistent. California law requires that employers pay employees the full tip amount indicated on the credit card. Employers are not allowed to deduct any fees charged by credit card companies.
Cash Tips
Regardless of whether your employees receive cash tips directly from customers or pool their tips with other employees to divide among one another at the end of their shifts, they must report total tips received. You have to include these tips in payroll so that they can be taxed and added to the employees’ W-2 forms.
Noncash Tips
Noncash tips are gifts like sports tickets, passes, and other items of value. If your employees receive any noncash tips as additional payment for their services, they are not required to report to you. Instead, they must report it as income on their tax returns. This means they must pay taxes on it, but you don’t.
Tip Pooling and Sharing
Tip pooling occurs when tipped employees combine their tips with other tipped workers on their shift to redistribute among them all. This is sometimes used interchangeably with tip sharing. Tip sharing is similar to tip pooling in that tips are redistributed but different in that both tipped and untipped workers like dishwashers and chefs receive a cut. If you require tip sharing and include nontipped employees, you must pay tipped employees the full minimum wage.
Federal laws don’t regulate how your employees should collect and distribute tips among themselves, so it’s up to you to create a policy for your restaurant if you want it to be consistent. Some states have specific tip pooling laws that override federal laws, so it’s a good idea to do your research or talk to a professional before setting policy.
Some common tip distribution arrangements are:
- Evenly: Tips are redistributed evenly among eligible staff
- Based on roles: Tips are split based on different proportions determined by position like 10% to bussers, 15% to bartenders, and 75% to servers
- Service benchmarks: Tips are allocated based on total hours or shifts worked
Be sure to notify your employees of your restaurant’s tip pool or sharing policy before they begin participating, or you could face compliance issues. Also, decide whether or not nontipped employees can participate. Federal law allows it, but you can determine what works best for your restaurant. Most importantly, ensure that your management team knows they cannot take tips distributed from the tip pool.
Automatic Gratuities
It’s standard for some restaurants to add an automatic service charge to a customer’s bill if there is a large party. Because these are imposed upon the customers and are not voluntary, you must report this as business income. Even if you collect and decide to distribute some or all to employees, you must report it on your tax return. However, you should be able to deduct it as a business expense, along with your employee wage expenses.
The IRS also requires you to report any service charges you decide to distribute to employees as wages. This means you must withhold and pay taxes on them. Keep a record of the employee’s name, address, social security number, the amount and date of each payment, and the amount of income and FICA taxes collected pertaining to the gratuities you distribute. The IRS may pay you a visit and examine your point-of-sale (POS) system to validate your payroll procedures.
Allocated Tips
If your restaurant has more than 10 employees, the IRS considers it a large food establishment and requires you to comply with allocated tip regulations. Allocated tips are amounts you must pay to tipped employees if total reported tips in a payroll period are less than 8% of your gross sales during the period or at a lower rate if approved. You can allocate tips annually, for the calendar year, or using any period that divides evenly into a year, biweekly, quarterly, and so on.
Use Form 8027 to report allocated tips, and enter the total in the “allocated tip” box on employees’ Form W-2 at the end of the year. Take note that income and FICA taxes are not withheld on these tips.
Here are three methods you can use to calculate the allocated tips you owe for the period and examples to help you understand.
We will use the following assumptions in each example, when applicable:
- Indirectly tipped employees like bussers and cooks who receive tips indirectly from customers reported $100 in total tips
- Directly tipped employees like servers and bartenders. who receive tips directly from customers reported $300 in total tips
- Directly tipped employees worked a total of 200 hours for the period
- Gross receipts are $20,000; $17,500 for directly tipped and $2,500 for indirectly tipped
To be eligible for the hours-worked method, you can’t have more than 25 employees. The allocation is based on the percentage of hours employees worked compared to the total hours all employees worked.
Here are the steps you need to follow to determine how many, if any, allocated tips you’re required to payout:
Step 1: Determine what 8% of your gross receipts amounts to.
$20,000 (gross sales) x 0.08 = $1,600
Step 2: Calculate how much of the 8% of gross receipts relate to your directly tipped employees by subtracting the total reported tips your indirectly tipped employees received as part of tip sharing arrangement from the 8% of gross receipts you calculated.
$1,600 (8% of gross receipts) – $100 (reported tips for indirectly tipped employees) = $1,500
Step 3: Calculate each directly tipped employee’s share of the 8% of gross receipts for the period by multiplying the amount calculated in step 2 by the following fraction: hours worked by tipped employee/hours worked by all directly tipped employees.
Let’s assume Susan, a tipped employee, worked 65 hours during the period.
Her share of the $1,500 (8% of gross receipts) calculated in Step 2 is 32.5%:
65 (Susan’s hours worked) / 200 (total hours worked by directly tipped employees) = 0.325 or 32.5%
$1,500 x 32.5%= $487.50
Susan’s share of the 8% of gross receipts for the period is $487.50.
Step 4: Calculate each directly tipped employee’s shortfall if any for the period by subtracting the tips he or she reported for the period from their total share calculated in Step 3.
Let’s assume Susan reported $350 in tips for the period.
$487.50 (Susan’s share of the 8% of gross receipts calculated in Step 2) – $350 (Susan’s reported tips) = $137.50 shortfall
Step 5: Calculate the amount that needs to be allocated among the directly tipped employees who had a shortfall for the period by subtracting the total tips reported by all employees ― directly and indirectly tipped ― from the 8% gross receipts amount calculated in Step 1
$300 (reported tips for all directly tipped employees) + $100 (reported tips for all indirectly tipped employees) = $400 (total reported tips by all employees)
$1,600 (8% of gross receipts) – $400 (total reported tips by all employees) = $1,200 (to be allocated)
Step 6: Calculate the number of allocated tips for each directly tipped employee by multiplying the amount that needs to be allocated (calculated in Step 5) by the following fraction: employee’s shortfall (calculated in step 4) / total shortfall of all directly tipped employees
Susan’s shortfall is $487.50 (as shown in Step 4). And let’s assume the total shortfall of all directly tipped employees is $1,050, which you can sum for your employees once you’ve completed Step 4 for each.
$487.50 (Susan’s shortfall) / $1,050 (shortfall of all directly tipped employees) = .464 x $1,200 (amount to allocate per Step 5) = $556.80
The total additional tips you should allocate to Susan total $556.80 for the period.
The gross receipts method is similar to the hours worked method with the exception that you divide gross receipts attributable to the employee by gross receipts attributable to all directly tipped employees instead of hours worked in Step 3. You can use this method, regardless of how many employees you have.
You can determine your own good faith method of allocating tips if you have a written agreement between you and at least two-thirds of the tipped employees in each work category like waitstaff and bussers.
The good faith agreement must do the following:
- Provide an allocation of the differences between total tips reported and the required 8% of gross receipts among tipped employees
- Begin on the first day of a payroll period after the date the agreement is adopted, but no later than January 1 of the following year
- Be adopted when there are tipped employees in each work category who would be affected by the agreement
- Allow for cancellation by a written agreement adopted by at least two-thirds of the tipped employees in the work categories affected by the agreement when it’s canceled; only effective at the beginning of a pay period.
We used the standard 8% requirement in our example, but if you feel the percentage of gross receipts you must use to determine the tip allocations doesn’t reflect the tips your employees are receiving accurately, you can request a lower rate. It can’t be lower than 2%, and you must file a petition with the IRS that justifies the lower rate.
To help justify, you’re required to provide specific information about your business like the type of service, hours of operation, type of clientele, and three years’ worth of tip reports to help the IRS estimate your actual tip rate. You’ll also have to pay a user fee when you submit the petition. Employees can choose to file a petition as well but only with the consent of a majority of the directly tipped employees.
Properly accounting for tips to ensure you maintain compliance can be a challenge. Keith Smith, CEO of Payouts Network, notes the challenges he’s seen restaurant employers face.
“With restaurants, more than 80% of sales are paid via credit/debit card, meaning tips are also paid via debit and credit card. Even with this push towards card payments, many restaurants are still manually paying those tips in cash. Managers spend 10+ hours a week maintaining cash reserves and disbursing tips when they should be focused on other tasks. It’s a highly manual and error-prone process that adds another layer of complexity to tracking payroll and is open to human error.”
LightSpeed POS makes it easy to accept and report tips. You can enter a tip pool rate if pooling is customary in your business, and a tips refund rate to deduct credit card fees.
Youth Pay and Laws
Hiring minors to work in your restaurant is a terrific way to give opportunities to young people who need experience and save on payroll costs. However, there are many laws you will need to comply with, or you could incur fines and other legal consequences. Some state laws are stricter than federal.
Youth Minimum Wage
It’s good to familiarize yourself with federal and state minimum wage laws regarding minors. Per federal guidelines, you can pay employees who are 20 years of age and younger a minimum of $4.25 per hour during their first 90 consecutive days of work unless your state or local laws prohibit it. Keep in mind that you aren’t allowed to displace other workers to hire a minor at a lower rate.
Child Labor Law
Under federal child labor law, you can only schedule minors who are 14 and 15 years old to work a maximum of three hours on a school day and 18 hours in a school week. In a nonschool week, they can work up to 40 hours for the week and eight hours a day. Minors age 16 and up can work an unlimited number of hours as long as the job is not hazardous.
The DOL provides more guidance on how to schedule minors on your payroll. You will need to consider some restrictions regarding starting and ending hours and many more nuances. State child labor law can be even more restrictive. You must maintain compliance with the regulations that give minors the most protection.
Hourly vs Salary
Owning a restaurant doesn’t mean you only have hourly employees. You may have a few administrative employees that you must legally classify as exempt, which essentially means you pay them an annual salary rather than an hourly wage. In most cases, you don’t have to pay these positions overtime as you would an hourly employee. However, check your state laws because guidelines vary.
Managing payroll for restaurant employees successfully requires careful scheduling and time tracking to prevent unnecessary overtime costs for hourly workers. If you need help managing your employees’ schedules, use a time clock and scheduling software, like When I Work. Try it free for up to 75 employees.
Full-time vs Part-time
You also have to decide on how many full-time and part-time employees you want to hire. There’s no hard rule regarding this, but most restaurants have a large population of part-time employees. It’s up to you, but keep in mind you may have to offer benefits like health insurance, as per the Affordable Care Act, if you have 50 or more full-time employees. You may also have to meet additional reporting requirements to maintain compliance.
Overtime
Overtime can be a huge challenge in the restaurant industry, primarily because you’re required to pay it at a higher rate than the standard pay rate so it can cause your payroll expenses to skyrocket easily. Another issue you might have is calculating it correctly. Generally, you’re required to pay employees at a rate of 1.5 times their regular pay rate for all hours worked over 40 in a workweek.
If you want to apply a tip credit as you would against the regular wage, you must first calculate the overtime rate and then deduct it before calculating the overtime pay.
Example:
Julian is a tipped employee who worked 45 hours during the workweek. He lives in a state with minimum wage laws that align with the federal minimum wage of $7.25, which means the maximum tip credit he can claim is $5.12. His tipped minimum wage is $2.13 ($7.25 – $5.12 = $2.13).
Let’s calculate his total pay for the week:
1: Calculate regular pay using employee’s regular hours ― up to 40 ― and regular pay rate.
Regular pay: 40 hours x $2.13 = $85.20
2: Use the employee’s regular pay rate to calculate the overtime rate.
Overtime rate: $7.25 x 1.5 = $10.88 per hour
3: Apply tip credit to the overtime rate to get the adjusted tipped overtime rate.
$10.88 – $5.12 = $5.76 per hour
4: Multiply the adjusted overtime rate by the number of overtime hours to get total overtime pay.
Overtime pay: 5 hours (45 total – 40 regular) x $5.76 = $28.80
5: Add employee’s regular pay and overtime pay to find total gross pay:
Total pay: $85.20 (regular pay) + $28.80 (overtime pay) = $114
Remember that some states have limitations on or prohibit tip credits altogether. In California, the tip credit is not allowed, and you must pay double overtime, instead of 1.5 times the regular rate, for 12-hour shifts or shifts of more than eight hours on any seventh day of a workweek. Be sure to check your state law for compliance requirements.
Frequency of Pay
Federal law gives you autonomy in deciding how often to pay your employees. It just requires that you pay them regularly, at consistent intervals. Each state has its own requirements, however, and the DOL breaks it down.
State Payday Requirements
Many states have multiple pay frequency requirements, some more lenient than others. If your state allows multiple pay frequencies, you should double check the DOL’s website for details on any specific requirements. For instance, Utah will allow you to pay salaried employees on a monthly basis, and California’s frequency of pay laws depend on the occupation. States like Alabama and Montana leave the decision up to you.
Checks vs Direct Deposit
You can opt to pay your employees via check or cash and direct deposit or pay card with employee consent. Although restaurant employees tend to receive a large portion of tips in cash, we don’t recommend you paying regular wages that way. Paying by check or electronic payment creates a paper trail and makes it much easier for you to retain documentation.
Checks
You may find printing payroll checks to be tedious if you don’t outsource or use payroll software, but employees who don’t agree to be paid electronically must have other options. It’s a good idea to include a pay stub, even though you may not be legally required to provide one. Tracking your employees’ — especially tipped employees’ — pay and taxes are essential for you to maintain compliance.
Pay stub laws vary by state. Some require printed or written stubs while others allow employers to issue electronic stubs. If you live in one of the following nine states, you’re not required to issue a pay stub at all, although you need to maintain adequate records: Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, Ohio, South Dakota, and Tennessee.
Direct Deposit
Processing payroll through direct deposit is the simplest option for you, especially if you use a payroll service like Gusto that offers it at no additional cost. If you are processing payroll on your own, remember to give your new hires a direct deposit authorization form during onboarding so that they can choose whether or not they want to opt-in.
Gusto will gather your employees’ consent and process direct deposits automatically. Run your first month’s payroll for free with Gusto.
Tip Reporting
The IRS requires that you report the tips your employees receive from customers as taxable income if they exceed $20 or more per month. This means you need to establish a solid tip reporting system to prevent anything from slipping through the cracks. You’re responsible for collecting and reporting income and FICA taxes on the reported tips.
Try using daily tip reports to help make restaurant payroll and tax reporting more accurate. LightSpeed POS provides an electronic tip reporting system that makes it easy for employees to enter their tips. Sign up for a free trial.
Employer Responsibilities
You have numerous obligations regarding employee tip income, including collecting taxes on tips, paying or depositing taxes, filing forms, and maintaining accurate records and reports.
Failure to comply could result in penalties and unexpected tax liabilities. According to federal rules, you must do the following:
- Retain employee tip reports
- Withhold employee state and federal income and FICA taxes based on wages and tips received
- Report all wages and tips paid to the IRS
- Pay your share of FICA taxes based on total wages and tips received by employees
Keeping track of your employees’ tips received is essential for you to determine how much to pay when it’s time to pay quarterly taxes. FICA taxes are generally 7.65% for both you and your employees, so you will need to withhold that percentage from their wages and tips paid in addition to matching the payment yourself. You can use the W-4 form they complete during onboarding to figure out what percentage to take out for income taxes.
Reporting
Your employees can use Form 4070 to report to you the tips they receive each month, including, cash tips, tips from tip pooling, and credit card tips. They can also use Form 4070A as a workbook to help track their tips on a day-to-day basis. As you review, make sure the total tip income they report each period is at least 8% of their total gross sales for the same period, or you may have to pay allocated tips. Don’t include mandatory service charges.
You’re required to submit quarterly tax payments and reports, similar to other businesses. Use Form 941 to report income taxes, social security tax, and Medicare tax withheld from your employees’ paychecks. You will also use it to pay your portion of social security and Medicare taxes. Use Form 940 to pay federal unemployment taxes (FUTA). Be sure to include your employees’ tips in the total wages paid to employees.
At the end of the year, you’re required to issue Form W-2 to all of your employees. It should show all wages and tips paid to the employee throughout the year in addition to Social Security, Medicare, and income taxes withheld and paid. You must also file Form W-3, which is essentially a summary of the W-2s you prepared, with the IRS by January 31 of the year after the year you are reporting. Submit it with copies of the W-2 forms you submit to your employees.
FICA Tip Credit
Tip reporting has its challenges, but the FICA Tip Credit you may be entitled to could make it all worthwhile. If your employees receive tips above the federal minimum wage requirement, you can take a partial tax credit. This tax credit will equal your portion of the FICA tax, currently 7.65% of total wage expense, multiplied by the reported tips in excess of the federal minimum wage.
Example:
Jolee earns $2.13 an hour, works 25 hours a week, and reports $300 in tips in a given week.
Step 1: Calculate weekly wages.
$2.13 per hour x 25 hours worked = $53.25
Step 2: Calculate employee’s total weekly income by adding reported tips to regular wages.
$300 (tips) + $53.25 (wages) = $353.25
Step 3: Calculate wages paid at the minimum wage rate.
$7.25 (federal minimum wage rate) x 25 hours worked = $181.25
Step 4: Calculate total tips in excess of the federal minimum wage.
$353.25 (total weekly income) – $181.25 (wages paid at minimum wage rate) = $172
Step 5: Calculate the total FICA tax credit you can claim on your tax return for the week by multiplying the 7.65% ― employer’s portion of the FICA tax ― by the total tips in excess of minimum wage.
$172 (total tips in excess of minimum wage) x 7.65% = $13.16
The total FICA tax credit you can claim on Jolee’s income for the week is $13.16. It may not sound like much, but over the course of a year, this could be $684.32 in savings ($13.16 per week x 52 weeks). If you determine you’re eligible for a FICA tip credit, use Form 8846 to claim.
Employee Responsibilities
You’re not the only one with tip reporting responsibilities. Your employees are legally obligated as well.
According to IRS regulations, all of your employees who receive more than $20 in tips should do the following:
- Create a daily tip record: Maintain a daily record of all tips (cash and credit) to report to you. They can use Form 4070A to stay organized if electronic reporting is unavailable.
- Create a monthly tip report: Report monthly tips of $20 or more to you by the 10th day of the following month. If the 10th falls on a weekend or holiday, the report is due the next business day. You can require more frequent reporting, but it can’t cover more than a one-month period.
- Report tip income in personal income tax: Report tipped income in tax return and document any allocated tips. Allocated tips only apply to large employers, with 10 or more employees.
If one of your employees fails to report all of his or her tips to you, you will not be penalized with late fees or legal action. When the IRS figures out your employee didn’t report all of his or her tips, you will receive a notice and demand for the taxes, at which time you will need to pay your share of FICA taxes. You won’t be required to withhold and pay the employee’s share of FICA taxes on the unreported tips though.
Meals as Fringe Benefits
Since you’re in the business of providing meals, it’s possible you may want to extend this benefit to your employees. Consider creating a meal policy outlining any discounted or free meals you’re willing to provide before, during, or after employee work shifts to minimize confusion. You should also take care to account for employee meals properly to keep reporting accurate.
You may be able to write off employee meals as tax deductions, so it’s important you have a good tracking system. Some POS systems will allow employees to enter food orders as employee meals, so investing in one could be a good decision for your business.
The IRS says you can exclude the value of meals from the employee’s wages if they meet the following tests:
- The meals are furnished on your business premises
- The meals are furnished for your convenience
This doesn’t apply to cash allowances. You must furnish the meals.
Example:
Don is a waiter working a 7 a.m. to 4 p.m. shift, and you furnish him two meals during each workday. You require Don to have lunch on the business premises but only encourage him to have breakfast there. Where he has breakfast is optional. Because Don is a foodservice employee and works during the regular breakfast and lunch periods, the IRS will allow you to exclude the value of Don’s breakfast and lunch from his wages.
This means neither you nor Don have to pay payroll taxes, FICA, FUTA, income taxes, and other taxes on the meals. If you allow Don to have meals in the workplace for free on his off days, you must include the value of those meals in his reported wages, which makes them taxable.
The IRS provides more guidance on how to handle different meal scenarios, but the gist is the same. If you’re providing meals for free during an employee’s work hours for your convenience, you don’t have to report them with employee wages.
IRS Tip Agreement
The IRS offers you the opportunity to participate in three voluntary compliance agreements that will save you from being subjected to a tip audit. It requires some additional administrative work to gather and present requested information in the required format, but the tax audit exemption you receive in return could be worth it. The goal of the program is to educate, make calculating and reporting tips easier for employees, and reduce the costs that usually come with tip audits.
Tip Rate Determination Agreement
The Tip Rate Determination Agreement (TRDA) requires you to work with the IRS to determine your tip rates, and at least 75% of your staff must voluntarily sign up for the program and agree to your tip calculation methods.
If you participate in TRDA, you will be required to do the following:
- Maintain records: You must commit to maintaining employee records and tip rates records for at least four years after the April 15 following the year they were reported
- Furnish information: You must agree to give the IRS a quarterly report of employees, total employees, and total employees participating in the tip agreement, and an annual report of nonparticipating employees
- Pay federal taxes: File, pay, and deposit federal taxes on time
- File Form 8027: File Form 8027 and pay allocated tips, if applicable, if you have 10 or more employees; We’ll provide more information on this later
The IRS also wants you to use historical information it provides to determine tip rates. A representative will review your tip rates at least annually and, in turn, commits to not pursuing a full tip examination while the TRDA is in effect. The IRS may evaluate you and your employees for compliance, but there won’t be a tip audit.
Tip Reporting Alternative Commitment
The Tip Reporting Alternative Commitment (TRAC) agreement focuses on education and tip reporting procedures.
If you participate in TRAC, you will be required to do the following:
- Educate new employees: Establish an educational program for new employees that explains tip reporting requirements per the IRS and your company tip reporting policy
- Educate existing employees: Establish a quarterly tip reporting education program for existing employees
- Establish tip-reporting procedures: Establish tip-reporting procedures that will allow employees to meet their reporting requirements per IRS rules
- File & pay federal taxes: File, pay, and deposit federal taxes on time
- File Form 8027: File 8027 and pay allocated tips if applicable if you have 10 or more employees; we’ll provide more information on this later
- Maintain records: Maintain records of gross receipts subject to tipping and charge receipts that show charged tips for at least four years after the April 15 following the year the records pertain to
- Make records available: If IRS service representative requests, you will make quarterly totals of gross receipts subject to tipping, charge receipts showing tips, total charged tips, and total tips reported available
In return, the IRS commits to not initiating any tip examinations of your establishment for any period in which you are under the TRAC agreement, unless it pertains to a tip examination of a current or former employee
Employer-designed Tip Reporting Alternative Commitment
The Employer-designed Tip Reporting Alternative Commitment (EmTRAC) program was created for companies in the food and beverage industry that are interested in designing their own TRAC programs. To participate, your restaurant must have employees who receive both cash and charged tips. Most of the requirements in the TRAC program apply to EmTRAC To participate, you must do the following:
- Educate new employees: Establish an educational program for new employees that explains the law’s requirement that they report all cash and charged tips to you
- Educate existing employees: Establish a quarterly tip reporting education program for existing employees
- Establish tip-reporting procedures: Establish tip-reporting procedures that will allow employees to meet their reporting requirements per IRS rules
- File & pay federal taxes: File, pay, and deposit federal taxes on time
- File Form 8027: File 8027 and pay allocated tips, if applicable, if you have 10 or more employees; We’ll provide more information on this later
- Maintain records: Maintain records of gross receipts subject to tipping and charge receipts that show charged tips for at least four years after April 15 following the year the records pertain to
- Make records available: If IRS service representative requests, you will make quarterly totals of gross receipts subject to tipping, charge receipts showing tips, total charged tips, and total tips reported available.
The EmTRAC program gives you autonomy in designing your educational program and tip reporting procedures, in which you can combine. According to the IRS, a POS tip reporting system could meet both of these requirements. And as with the other IRS tip agreements, the IRS will not initiate a tip examination unless it pertains to the tip audit of a current or ex-employee.
Terminating the Tip Agreement
If you sign up to participate in one of the tip agreements, you can terminate at any time. The IRS may also terminate the agreement if you fail to comply with the requirement or punitive action is pursued by an IRS service representative. The IRS may also terminate the TRDA if less than 75% of your employees at the end of the year participate in the program.
Employee Paycheck Deductions
When the time comes to process payroll for restaurant employees, you will need to review your deductions for accuracy. Because restaurant payroll can sometimes be challenging, you will want to make sure you don’t miss anything. Failing to pay taxes or the correct tax amount on wages and tips can result in significant fines and penalties.
Here are some possible deductions you can expect to withhold from your employees’ paychecks:
- Social Security & Medicare (FICA)
- Federal unemployment tax
- State income tax
- Benefits
- Tax deductions on employee tips
- Tax deductions on meals
Other Deductions
Under federal law, deductions for required uniforms, cash shortages, or walk-outs are allowed as long as they don’t reduce the employee’s earnings below minimum wage or cut into overtime pay. Other costs, like tools your employees need to work, damage repairs due to employee negligence, and theft are also allowed.
Example:
If your employee is subject to the minimum wage of $7.25 per hour and is paid an hourly wage of $7.25, then you may not make any deduction from the employee’s wages for the cost of the uniform, nor may you require the employee to purchase the uniform on his or her own. However, if the employee is paid $7.75 per hour and worked 35 hours in the workweek, the maximum amount you could legally deduct from the employee’s wages would be $17.50 (50 cents x 35 hours).
Storing and Securing Payroll Records
Payroll records contain sensitive information, and you don’t want everyone to have access. It’s important to find a safe and secure way to maintain them so you can access when necessary. The IRS can decide to audit your tip reports at any time, and it’s best to be prepared.
Many payroll software providers, like Gusto, offer electronic storage as a complementary part of the software. This means that any payroll records you generate, like pay stubs, new hire forms, and W-2s, are stored within the system and can only be accessed by individuals you allow. A POS system, like LightSpeed POS, can store your tip records.
However you decide to store your payroll records, you should keep them for at least three years per federal law. As usual, your state laws regarding payroll records may differ, so it’s worth taking a look.
Other Labor Laws
You may be subject to other labor laws beyond what we’ve already discussed. Federal law has rules regarding workplace posters you’re required to post, and states have various regulations governing workers’ compensation, paid-time-off, child labor laws, and so on. It’s a good idea to reference your state agencies.
Workplace Compliance
Federal and state laws require you display certain posters in your workplace so that employees know their rights. Some posters you are required to post are the Minimum Wage, Workers’ Comp, Family Medical Leave, and Occupational Safety and Health Administration.
To get a complete listing of the posters you are required to display under federal law, visit the DOL’s FirstStep Poster Advisor. It will ask questions about the industry your business is in, state, number of employees, and more, and helps you determine what you need to maintain compliance.
For information on state poster requirements, check your state’s DOL. You can print some posters for free online. LaborPosters.org maintains both state and federal posters on its website.
Workers’ Compensation
Workers’ comp insurance policies protect you from being held liable in the event that any of your employees get hurt or die due to injuries in the workplace. Check your state requirements to see what your responsibilities are for purchasing workers’ compensation insurance. Most states except Texas require it, but they typically have different procedural rules for implementing. To find out the details of your state’s law, contact your state workers’ compensation department.
State Compliance
We’ve talked a lot about the specifics of maintaining federal compliance when processing your restaurant payroll, and we’ve also addressed some state requirements. We encourage you to check your state’s regulations because some states have additional requirements that could result in more payroll expense and reporting.
Here are a few areas you should review regarding to your state:
- Disability insurance requirements
- Leave of absence regulations
- State, city, or municipal income taxes
- Minimum wage requirements
- Workers’ comp regulations
- Unemployment insurance
- Child labor laws
- Meal and break time
- Paid time off
Remember when federal and state requirements differ to follow the laws that give employees the most benefits and protections.
Restaurant Payroll Frequently Asked Questions (FAQs)
Below are questions small business owners may have when running restaurant payroll.
Can I use a tip credit to lower the hourly wage I pay to employees who have dual jobs when one of their jobs is nontipped?
Yes, but federal law will only allow you to take the tip credit for hours the employee spent in the tipped occupation. You can take the tip credit for time that the tipped employee spends doing indirect tip-producing work like setting and cleaning tables only if it’s related to the tipped occupation and takes less than 20 percent of their time during the workweek.
Can employers require tipped employees to share with back-of-the-house employees that don’t usually receive tips?
The federal law was amended in 2018 to include nontipped positions like cooks and hostesses to participate in tip sharing. If employers do opt to enforce such a policy, they must pay all employees at least the full $7.25 federal minimum wage. They aren’t allowed to take the tip credit. State and local laws may have stricter minimum wage requirements.
What taxes do restaurants pay on tips?
If an employee regularly earns over $20 per month in tips, restaurant employers must pay Social Security and Medicare taxes (FICA), generally 7.45% and both federal and state unemployment taxes at around 6%. Other state and local taxes might apply, so it’s good to double-check your figures.
What rules do employers have to comply with regarding tipped employees?
Employers can take a tip credit to lower the hourly wage they pay tipped employees, but if the employee’s earnings for the week are less than minimum wage when tips received and tipped wages are combined, employers must pay the difference. Taxes and regular reporting are also required, and neither employers nor a restaurant’s management team are allowed to take any of the tips. Restaurants with more than 10 employees are also subject to allocated tip requirements.
Can restaurant employers pay out service charges to tipped employees to avoid reporting it as business income?
Service charges must be reported as business income for the restaurant and taxed per the IRS, regardless of distribution to employees. Service charges aren’t allowed to be treated as tips to employees if they’re mandatory and the customer doesn’t get to determine the amount or who receives.
Bottom Line
Restaurant payroll is subject to many rules and regulations that get even more complicated when state laws override federal. The primary challenges employers face are how to pay and report wages and taxes for tipped employees. Before you hire your first employee, you should consult with a legal advisor to ensure you comply with all labor laws fully.
To simplify tip reporting for you and your employees, consider using a restaurant POS like LightSpeed POS. It has features that allow employees to track and record their daily tips electronically as well as synced reports you can use to comply with tipped reporting requirements. Sign up for a trial today.
