Teaching Kids to Be Responsible with Money

Reporting Tip Income On W-2 Forms Provided To Restaurant Employees

by Ian Wallace

Restaurant managers have an added payroll responsibility in that they must keep track of tip income received by employees. At the end of each year, restaurant operators must provide a Form W-2 to each employee.

Form W-2 entries

For employees elsewhere who do not receive tips, a Form W-2 is likely to include all wages in box 1 of the form. For a tipped employee, income is also reported in box 7 and possibly box 8. The difference is because restaurant workers usually receive tip income in addition to a fixed pay rate.

The federal minimum wage for tipped workers is $2.13 per hour. Some states have their own higher minimum wage that affects tipped employees. For restaurant workers, the amount of income based on a fixed rate is considered wages and is reported in box 1 of Form W-2. Tip income is reported in box 7 or box 8, depending on whether or not it was reported to you by your employee.

Box 7 of Form W-2 contains the amount of tip income reported to you by the employee. In addition to federal income tax, Social Security tax and Medicare tax is withheld on the reported tip amount. Some restaurants with a low level of reported tips may be required to calculate an additional amount to include in box 8 for each tipped employee.

Tip allocation

For payroll tax purposes, reported tips are generally expected to be at least 8 percent of total restaurant revenue. If reported tips are less than 8 percent of revenue, the difference must be allocated among all tipped workers. The allocated amount for each individual employee is reported in box 8 of Form W-2. Allocated tips are fully taxable to employees, but there is no up-front requirement for you to withhold payroll taxes on the allocated amounts.

IRS Form 8027

Some larger establishments are required to go an extra step and file an annual form to calculate and report their tip allocation. IRS Form 8027 is generally required of food or beverage establishments that have over 10 employees on a full-time basis. Form 8027 is not required of a restaurant where tipping is not customary.

If the tips received at your restaurant are consistently less than 8 percent of revenue, you can request a lower allocation threshold, as low as 2 percent. The instructions for Form 8027 explain how to submit a request to lower the level at which tip allocation is required.

Tip income is taxable to your employees, but it is equivalent to wages for purposes of funding retirement accounts or claiming valuable credits. Contact a payroll service like Risley Annette CPA for more information on Form W-2 completion.