Tip income is an important area of concern for several types of businesses. Employers are responsible for including tips received by workers on their W-2 forms.
Workers must report to their employers the total tips received in a calendar month whenever the amount exceeds $20. Employers include reported tips in calculations for withholding of income tax as well as Social Security and Medicare taxes.
Box 1 on a W-2 for wages should include reported tips. In addition, Boxes 3 and 5 for Social Security wages and Medicare wages are applicable for reported tips.
Paychecks can possibly have insufficient wages to cover withholding requirements on tip income. Any required withholding that isn’t collected is reported in a special box on Form W-2. This figure should match the adjustment on an employer’s quarterly federal payroll reporting. Alternatively, workers may give their employers money from collected tips to cover calculated withholding amounts.
Food and beverage businesses have a special rule about tips. When reported tips are less than 8% of gross receipts, most food and beverage establishments must calculate the deficiency. This figure is then allocated among employees according to a formula based upon proportions of gross income or hours worked. Allocated tips are indicated in a special box on Form W-2. No withholding is required on allocated tips.
The IRS has escalated enforcement of tip-reporting rules. Businesses in industries where tipping of employees is common should ensure that compliance measures are executed for all income from tips.