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When Is a Tip Just a Tip?

June 3, 2013

When Is a Tip Just a Tip?                                                                                 
Tipping in the hospitality industry is considered the normal course of business.  However, the IRS considers tipping, in certain situations, to be taxed differently through payroll.  Employers in this industry now need to be diligent in their recordkeeping.  Here are some quick tips on how to differentiate employees’ tip income:

·       All reported cash tips totaling $20 or more in a calendar month are taxable income. 

·       When a tip is a voluntary from a customer patronizing your business and the amount is determined by the customer, it is truly considered tip income.

·       If the employer includes a mandatory service charge or gratuity on the customer’s bill and distributes the service charge to the employee(s) working, then this is considered “ordinary income”.  This income is added to the employee’s gross wages and is NOT classified as tip income. 

·       Every payroll, service charged tips should be placed into the employee’s gross income rather than added to their accumulated tip tracking for the pay. The IRS has provided interim guidance on Revenue Ruling 2012-18.

IRS Revenue Ruling 2012-18 states that unless four factors are present, doubts exists as to whether the payment is a tip and may indicate the payment is a service charge.  The four factors are:
1.     The payment must be made freely without compulsion
2.     A customer must have the unrestricted right to determine the amount
3.     The payment should not be the subject of negotiation or dictated by employer policy and,
4.     A customer generally has the right to determine who receives the payment
Other amounts that can also be treated as service charges may include room service charges, contracted luggage assistance charges, bottle service charges, mandated charges for deliveries for pizzas and other retail deliveries.
The IRS has said that employers must be cautious when distributing service charges to ensure proper withholding within each payroll cycle.
Payce is the endorsed payroll provider for the Restaurant Association Metropolitan Washington.