Employer Allocation of Tips
In regard to taxes, the issue of tip allocation primarily applies to the wait staff and bar staff at large restaurants.
Tip allocation is applicable to “large food and beverage establishments” (i.e., food service businesses where tipping is customary and that have ten or more employees). These establishments must allocate a portion of their gross receipts as tip income to those employees who “underreport”. Underreporting occurs if an employee reports tips which are less than 8% of the employee’s applicable share of the employer’s gross sale. The employer must allocate to those underreported employees the difference between what the employee reported and the 8%. The 8% allocation is made only among those employees who normally receive tips. The allocation amount is noted on the employee’s W-2 but does not have to be reported as additional income if the employee has adequate records to show that the amount is incorrect. Note that the allocated tips are not included in the total wages shown on the employees’ W-2. (The IRS has issued inquiries where the taxpayer’s W-2 showed an allocation of tips and none were reported on the tax return.)
A Method of Lowering the Allocation Percentage
If customers at an establishment tip lower than the regular allocation percentage (8%), either the employer or a majority of the direct employees may petition to have the percentage reduced from 8% (but not below 2%). The petition is made in writing to the Internal Revenue Service, National Tip Reporting Compliance, 3251 N Evergreen Dr., NW, Grand Rapids, MI 49525. See the instructions to IRS Form 8027 for the specific information and documentation required to accompany the petition. Payment of the user fee for determination letters is required at the time the request for a lower rate is filed with the IRS.
Employer Social Security Credit (IRC Sec 45B)
Food and beverage establishments can get a tax credit for a part of employer social security taxes paid on their employees’ cash tips. This credit is part of the general business credit (Form 3800); however, Form 8846 is used to compute the amount of credit. The credit amount is equal to the “excess employer social security tax” paid (or incurred) for the year. The credit is elective by the employer in lieu of deducting the excess social security tax as a business expense.
“Excess employer social security tax” is that social security tax paid by the employer on tips received and reported to the employer by the employee during the given month, to the extent the tips are:
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Considered to have been paid by the employer to the employee under Code Section 3121(q), and
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More than the amount by which the employees’ actual wages for the month (without inclusion of any tips) are less than $5.15 an hour. If each employee was paid an amount equal to or more than $5.15 per hour (excluding tips), then the credit is computed on all reported tips. (Form 8846 line 2 instructions)
“ Example – Employer Social Security Credit : Jerry, a waiter, worked 100 hours and reported $400 worth of tips to his employer during January. Jerry’s regular wages (at $3.25 per hour), without considering tips, during that period were $325, bringing the total to $725. If Jerry had been paid $5.15 per hour, he would have received $515. The result is that only $210 ($725 - $515) of the employee’s tips for January is taken into account for the purpose of computing credit. The employer's credit amount is $210 x .0765= $16.07. If Jerry’s hourly wage had been $7.00, then his employer’s credit would be $30.60 ($400 x .0765). ”
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