Reporting Allocated Tips to the IRS

Tips are positive affirmations from your customers, but if you don't report them, you could be setting yourself up for tax problems. If you own a restaurant or another business where tips are customary, you'll need to understand Internal Revenue Service regulations about reporting employees' income from tips and related gratuities. Here are some guidelines about what types of establishments need to report employees' tips, how you should calculate tip income, and how to report allocated tips to the IRS.

Determining whether your restaurant should report tip income

Restaurants obligated to do so generally must fall under each of the following three criteria:

1. Food and beverages must be consumed on the premises.
2. Tipping must be a "customary" practice. Restaurants that add a service charge to the bill and establishments where tipping isn't expected, such as fast food restaurants and cafeterias, are generally excluded from this rule.
3. Within the previous calendar year, your restaurant must have employed more than 10 people on a typical business day. If the average number of hours worked per business day by all your food and beverage employees combined was more than 80 during any month last year , then you have 10 or more employees according to the IRS. If your business opened after December 1, 1997, or was open for less than one calendar month last year, you qualify if you've exceeded the 80-hour average for two consecutive months in the current year.

Calculating the total tip income for your business

Follow these steps to figure the total amount of tips your business must allocate:

• Decide on an allocation period. You can use a regular payroll period, a calendar year, or a calendar month.
• Calculate your restaurant's total food and beverage sales during this allocation period. Do not include take-out sales, state or local taxes, or sales on which there was a service charge of at least 10 percent.
• Multiply the total sales for your allocation period by eight percent. For example, if sales for your allocation period are $200,000, the tips your business must allocate would be $16,000.

If customers normally tip less than 8 percent, the employer or a majority of employees may apply to the IRS to have the percentage used in the allocation reduced from 8 percent to as low as 2 percent.

Allocating tips to your employees

Once you've calculated the amount of tip income that your business must report, compare this figure to the total tip amount reported by your employees during the same allocation period. If your employees have reported less than the amount you're required to allocate, you'll have to divide the difference among them.

You can allocate tips according to any formula that you and your employees agree upon, as long as at least two-thirds of each category of tipped employees, such as waiters and waitresses, bartenders, and busboys, agree to the formula in writing. Some restaurants apportion the difference equally among all employees who regularly receive tips. Other restaurants divide the difference according to how many hours each employee has worked or by the employee's share of the gross receipts earned by the establishment during the allocation period. Regardless of the allocation formula you use, you should not allocate additional tip income to any employee who has already reported tips equal to or greater than 8 percent of their total sales.

Reporting allocated tips

Allocated tips must be reported as additional income on each employee's W-2 Form (in Box 8). Employers should not withhold any taxes on allocated tips.

To report allocated tips for your business, you'll need to submit IRS Form 8027, Employer's Annual Information Return of Tip Income And Allocated Tips, with the following information:

• Your restaurant's name, address, and employer identification number (EIN).
• Your restaurant's name, address and establishment number.
• The total gross receipts from food and beverage sales, excluding carryout sales, state and local taxes, and sales covered by a minimum 10 percent service charge.
• The total amount of charge receipts on which customers showed tips.
• The total amount of tips your employees reported for the year.
• The total amount of service charges of less than 10 percent collected from customers and paid to employees as wages.
• The name and social security number of each employee to whom tips were allocated.

For a more information about allocating and reporting tips, have a look at the online resources below.

• Download IRS Form 8027
  You'll need a copy of the Adobe Acrobat Reader, which is available for free, to read and print Form 8027.
• Publication 15 Circular E, Employer's Tax Guide, Tips Section
  Everything you need to know about reporting your employees' tip income, including allocating tips
• IRS Publication 531: Reporting Tip Income
  Detailed instructions for your employees about reporting tip income
  

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