Effective January 1, 2014, restaurants and other employers with tipped employees must change the way certain tips are reported. Although Rev. Rul. 2012-18 took effect in 2012, examiners in some circumstances could apply it to amounts paid after December 31, 2013. Therefore, all employers must comply with Rev. Rul. 2012-18 starting in 2014.
Payments Traditionally Treated as Tips Must Now Be Treated as Service Charges
Certain payments that tipped employees receive and employers called tips must now be treated as wages. Since these wages are subject to withholding, they should be paid in the employee’s paycheck. Although there is a line on Form 941, Employer’s QUARTERLY Federal Tax Return, to report the uncollected employee share of social security and Medicare taxes on tips, there is no line to report such uncollected taxes on wages or service charges treated as wages. In order to collect and pay these taxes, therefore, the service charges should be paid on the employee’s paycheck.
Employer’s Characterization of Amounts as Tips Is Not Relevant
The Internal Revenue Service (IRS) states that it is irrelevant whether or not the payment is called a tip. According to the IRS, “the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge.” The four factors listed are the following:
- The payment must be made free from compulsion;
- The customer must have the unrestricted right to determine the amount;
- The payment should not be the subject of negotiation or dictated by employer policy; and
- Generally, the customer has the right to determine who receives the payment.
Mandated Tips and Suggested Tips
Examples provided by the IRS distinguish between mandated tips and “suggested” tips. In the former case, the menu dictates that an 18% gratuity will be added for parties of six or more. Since the amount is added to the charged amount by the employer and the customer did not have the unrestricted right to determine the amount, this payment is considered wages, not tips. Alternatively, if the check simply shows sample tips amounts of 15%, 18%, and 20% and the customer chooses one of the suggested tip amounts, the amount is still considered a tip for payroll tax purposes.
Service Charges Should Not Be Reported as Tips
Employees are generally required to report cash tips (including amounts paid on credit cards and received in a tip-sharing arrangement) to their employers, and those cash tips are included in gross income of the employees. Amounts determined to be wages and not tips under these provisions should not be included in the amounts reported to employers.
Contact Vision Payroll if You Have Questions on the New Rules on Tips