QuickBooks Small Business

Accounting & Payroll Issues for Restaurant Tips and Service Charges

Written by Stacey Byrne

In part one of this two-part series on restaurant accounting and payroll, I’ll discuss the difference between tips and service charges, tip reporting requirements, and accounting for cash tips, credit card tips and service charges. In part two of this series, I’ll examine the payroll considerations for tips and service charges and how to record payroll from an outside payroll service provider, as well as examine the employer tax credit for tipped employees, including how to calculate and file for this substantial tax credit.

Stacey Byrne will present the session, TAKE CONTROL: MANAGING DIFFICULT CLIENT RELATIONSHIPS, at Accountex 2017.

One of the most challenging elements of restaurant accounting is paying and taxing cash and credit card tips. Some of the money is already in the servers’ pockets, and some is in the restaurant’s bank account.

Did you know that the automatic gratuity added to the check for large parties is not actually a tip? The restaurant does not have to give a dime of that money to the server. Or, did you know that the restaurant is entitled to a tax credit on the payroll taxes paid on employee tips? For employees paid $5.15 per hour or more, a 100% annual tax credit is available on the FICA taxes paid by the employer throughout the year.

Tips Versus Service Charges

Many people assume that the automatic gratuity of 18% for a large party is a tip for the server when actually none of this money has to go to the server. Tips and service charges are reported differently on payroll reports and in the restaurant accounting. According to the IRS, in order to determine if a payment is treated as a tip, these four factors must be considered:

  1. The payment must be made free from compulsion;
  2. The customer must have the unrestricted right to determine the amount;
  3. The payment should not be the subject of negotiations or dictated by employer policy; and
  4. Generally, the customer has the right to determine who receives the payment (i.e., the server and anyone the server chooses to or is required to pool or share the tips with).

If these factors do not justify the payment being treated as a tip, it is treated as a service charge.

Payroll Issues

In the example pictured above, the 18% gratuity fails all four of these tests: the customer is compelled to pay an amount negotiated solely by the restaurant, and the customer is not able to choose how much to leave or who receives it. This payment needs to be treated as a service charge. We will discuss the accounting treatment of each scenario later in this article, and the payroll considerations and the effect on the employer tax credit on reported tips in part two.

Tip Reporting Requirements

When employees fail to pay taxes on their tips, the IRS considers this a form of tax evasion. Unreported tips will also cause an employee’s W-2 income to be lower than it actually is. Unreported income becomes a problem when an employee applies for a loan and finds out their income is too low to qualify.

The restaurant is also taking a big risk in the event of an audit. It is easy for an auditor to discover unreported tips if no tips are reported through payroll. It is also a certainty that if an establishment has credit card tips, there were also cash tips. It is important for the restaurant to require employees to report all of their tips or the restaurant runs the risk of incurring additional taxes and penalties for failing to report and tax the tips.

It is the employee’s responsibility to report the amount of cash and credit card tips received to the employer. It is not the employer’s responsibility to keep track of the tips collected by each employee. While the employer may know how much a particular server collected in credit card tips, the employer has no way to know how much cash a server picked up off the tables, nor does the employer know the amount of tips that server shared with the busser or the bartender.

The employee reporting can be accomplished with a form similar to the example shown below.

Form 4070

This exact form does not have to be completed, but the same information needs to be on whatever format you use, including an employee signature. An example is provided by the IRS for the employee to use to keep track of his or her daily totals. The IRS suggests tips be reported at least monthly; however, it is best to get this report on a daily or, at most, weekly basis so you can be sure the employees are providing accurate and timely information.

Accounting for Cash Tips

When a customer leaves a cash tip on the table, the money goes right into the server’s pocket. While these cash tips need to be taxed for payroll purposes, there is no effect on the restaurant accounting. There is no entry to be made whatsoever. We will discuss the payroll treatment of cash tips in part two of this series.

Cash Tips

About the author

Stacey Byrne

Stacey Byrne (@SLByrneCPA) is a practicing CPA with 25 years' experience consulting with a variety of small to medium-sized businesses including restaurants, construction companies, law firms, and not-for-profit organizations. She is the co-author of Restaurant Accounting with QuickBooks, with Doug Sleeter. Stacey has worked as a staff accountant at the Iacopi, Lenz & Co. CPA firm, and is the former director of finance for a management company where she oversaw accounting and payroll for multiple facilities, including a sports/entertainment arena, theater, ice rink, and ballpark. She is a former adjunct professor of QuickBooks at San Joaquin Delta College in Stockton, California.

Stacey holds several Intuit certifications in QuickBooks (Advanced Desktop, Advanced Online, and Enterprise). She is a certified Sleeter Group QuickBooks consultant and a certified Xero Partner.

Stacey holds a B.S.B.A. degree in Accounting from California State University, Stanislaus, and is currently in pursuit of her M.S. Ed. degree in Online Teaching and Learning at California State University, East Bay. She is also a member of several professional organizations, including the California CPA Society, Sleeter Group Consultants Network, and the Woodard Network.

When she is not writing, working with clients, or studying, you will likely find Stacey at a San Francisco Giants game or enjoying family time with her two sons.

43 Comments

  • Oh wow! I never knew about the gratuity not being a tip! I always thought it went to the server as a tip. Next time I am in a restaurant and I see that a certain percent is charged for a group over X I am going to ask how much of it will go to the server. I don’t like the thought of a server getting no tip, but I also don’t think it is right to leave a tip when a gratuity is added.

    • Thanks for your comment Elizabeth. Knowing whether to tip or not to tip on top of a service charge is perplexing, to say the least. To top it off, a lot of restaurants don’t understand that the service charges are income and (in California) are subject to sales tax. If they DO share the tips with the servers, it has to be treated as regular wages.

      • I remember about 10 years I worked for an accounting firm in the payroll department. One of my clients was a restaurant. I occasionally ran into trouble with servers who made huge tips combined with a small hourly wage. The tips were added into the gross, taxed then deducted after taxes. Occasionally I had to hold over some of the tips to the following payroll because I couldn’t calculate a zero net check. Not sure if that’s the way payroll for restaurants is done now. I guess I will just have to wait for part 2 of this article. 🙂

        • Tax shortfalls are not covered in part two, but you will find other useful information in that article. We don’t see this situation much in California because of the higher minimum wage, but the IRS has guidelines on how to handle this. It can get very complicated. IRS Tax Topic 761 discusses this situation in detail.

      • As a restaurant owner it is financially tough for me on having to pay taxes for credit card tips which are huge that I pay out everyday. None of which I see a dime of. Why can’t I just put all their tips on a W-4 in the tips area and THEY pay taxes on THEIR money. I pay plenty on their wages. I just can’t understand. Please help!

        • Paryse,
          The reason you can’t just put all their tips on a W-4 and let the employees pay their own taxes is because that is not how the employment tax laws are written. As the employer, you are matching the social security and medicare taxes on the tips. You are also entitled to a tax credit on those taxes. Talk to your tax preparer about the tax credit that is discussed in part 2 of this series.
          Stacey

  • Finding the right accountant that can give you the best results for your taxes. My brother told me to ask questions that you know or have researched and see what they say. Always good to keep these in mind.

  • The restaurant I work in does an automatic gratuity of 20% for large parties. In order to circumvent this, I will add a tab that was paid in cash and then void the service charge. This allows an instant cash tip for the server.

    • Automatic gratuities cannot be paid out in cash as tips. These are income to the restaurant. If any of the service charges are paid out to employees, it has to be paid as wages.

  • Hello Stacey Byrne you have written positively minded tips which are very informative i have got more payroll business tips it will help me for my payroll management system .
    Thanks for sharing your creatives content

    • There are several different principles in this article. Many of these principles can be applied across different industries such as accounting for the tips. You will need to consult with a tax advisor for more specific answers. I can tell you that the tip credit is only for food and beverage establishments.

  • For business owners with employers, payroll is a necessary task that can slow your day and tie you down if you let it. If you hire a lot, empower your new hires by letting them do their paperwork for you. A good payroll system allows employees to “onboard” themselves, completing the I-9, W-4, and direct deposit authorizations electronically, even before they show up for their first day. You’ll still need to ask for ID on their first working day, but at least you won’t have to do their paperwork for them.

  • I have a question for you Stacey. The resultant where my wife works allows her to take home her cash tips at the end of every night, but her credit card tips they keep overnight, then return to the servers the next day. here’s the thing that throws me off tho they take 20% out of her credit card tips and say that they are putting it in there check to pay taxs. I look at her paycheck stubs and no where on there does it show this 20% deduction. no employee seems to fully understand this tactic. any help would be appriciated!!

    • The employee should see Tips as an addition on their check stub. The taxes will come out as Social Security, Medicare, etc. You will also see Social Security Tips and Social Security Wages in different boxes on the W-2.

  • Hi Stacey, I have a question for you. My employer requires me to hand over my cash tips. They are recorded and paid out on my paycheck every week. If the cash is technically my property once handed to me, is it okay for my employer to require me to give it to them, as long as they give it back? Thanks for your input 🙂

    • I am not an attorney. What I am typing is not legal advice. It depends on your state. In California, cash tips are payable to the employee when they are received. The employer is not allowed to interfere with that (not even to make sure the employee can cover the payroll taxes). What you are describing could also be against the law in your state. In California, labor code section 351 says that no employer shall take any gratuity that is paid, given to, or left for an employee by a patron. It may be worth a call to your state’s labor board.

      • Hi just a follow up question, so my coworker got tipped $1000 dollars in July, fast forward to September the customer that tipped her came back and asked for the refund, for which the owner of the store gave it back to her. But now is asking my coworker to pay her back the $1000. That would be something we seek legal help for and not an accounting for correct? The information you provided was very helpful 🙂

  • So back to my post earlier. If gratuity is added and is paid in cash, do you have to turn in that money in to go on your check later. Every restaurant that I’ve worked at that still does auto-grats, allows you to void it and keep your cash tip.

    • Craig,
      If your employer is voiding the service charge and allowing you to keep the tips, that is illegal. The publications referenced in this article explain proper treatment of auto grats. They need to be included in income for the restaurant and paid out to employees as wages. Voiding the auto grats and treating them as tips is not covered in the publications.

  • Hi, I work for a large spa chain as a Massage Therapist. (Employee) They give us our cash tips to take home at the end of our shift as ours, but credit card tips are kept and included with our income on our pay check and taxed. How does this work when doing my taxes? Very confused…

    • Your W-2 should properly reflect your tips. The cash tips, although they are paid to you each shift, still have to be included in income so you can pay tax on them.

  • Hi Stacey,
    I am the owner of a restaurant, what is the accounting on the profit and loss for the FICA credit I already claimed on the income tax return (S corp or LLC). What is the journal entry to make in QuickBooks to reduce the payroll tax expense if I designed to claim the FICA credit on the income tax return?

  • Jenny,
    The credit is a general business tax credit, it is not a reduction of payroll tax expense. You don’t get to deduct BOTH the payroll taxes and tax the credit. Please seek help from your tax advisor on how to record this in your books.

    • Hi Stacey,
      Do you mind to give me a little bit more guidance? I disagree with my tax advisor and seeking a second opinion about the treatments on the FICA credit. I understand I don’t get to deduct BOTH the payroll tax and tax the credit. So my tax advice made an adj journal entry to subtract the FICA credit amount we have taken from actual paid out payroll tax expense. Thus that affecting the P & L- payroll tax expense would be less than the real payout. Do you think this is the right way, and I feel it’s not necessary to do the journal entry. I guess the FICA credit is a treatment on the tax return but not affecting the P & L. I appreciate if you can give me your thoughts. Thank you.

      • There is generally a Schedule M-1 on the S-corp tax return that reconcile net income on the books to net income on the tax return. JEs are not always necessary.

  • Hi Stacey.

    1. I only can use the service charge for pay waiters salary.
    2. If I cover the minimum wages with the service charge, the outstanding money what can I do with that?.
    3. If I want to put the 4% of service charge instead of 18%, I can do that?.
    4. There is any % of the service charge I can to use for pay wages or I can use all to cover the minimum wages and overtimes?.

    Regards.

    • We don’t have these issues in California, because everyone is paid full minimum wages, but let me do my best to address your questions.

      1. When service charges are paid to staff, they are treated as wages. I don’t know why you would be limited to only pay to waiters.

      2. If you mean “outstanding money” is the difference between what you charged the customer and what you paid to staff, the difference will remain as income to the business. If you collect $1,000 as Service Charge Income and pay out $400 of Wage Expense, you will have $600 sitting there as net income. You can do whatever you want with the money. That is the key difference between tips (100% belong to employee) and service charges (Income to the business, and any amount paid out is Wage Expense)

      3. Not sure what your question is here. You can charge whatever you want as a service charge, and can pay out all of it, none of it, or any percent you choose.

      4. If you are paying out the service charges as Wages, the amount paid can be counted towards minimum wage. But this will also affect the hourly rate used to calculate the overtime rate.

      There are several federal resource links on my website under Restaurant Resources. I am unable to post a link in the comments. Please check these links for more information.

  • It’s good to know that tips shouldn’t hit the income statement. I’d imagine that a tip pooling software could be useful for managing tips as well. Splitting tips between servers and chefs has to be pretty important.

  • Hello I need help I counted in cash that I have 1,125 in hand and in sales for a week 1,944.97 and in the credit card 1244.72 with tip and I get 700.25 why do I have extra money what am I missing

  • Hi Stacy,
    I am the bookkeeper for a restaurant. We are using QB Online. Our P & L’s are showing the credit card tips our servers make as an expense. We want to make sure it is shown as a Liability. However, when you download transaction from the bank feed into your register, it gives the total amount paid to the employee. How can fix this? Is this a Journal Entry that our accountant has to fix?

  • Hi Stacy
    I still dont get the accounting for Tips.
    I collected tips though Clover. Debit Bank $740 => Credited Current Liability Tips payable $740
    ADP came in the pulled the funds associated with the Tip from the Bank Account
    Credit Bank $740 => Debit Net Payroll $700 , Debit Employee Tax deductions on the Tip $40
    So my Bank Rec’s balance. My Balance Sheet still shows a Liability of $740 which has been fully paid out. How on earth do I clear?

  • Hi Stacy just a quick question:
    I work for a restaurant and receive my credit card tips in my paycheck with my hourly rate of $8 per hour including a portion of cash tips. after it is added to the gross amount they tax it, then to get to net pay they deduct the cash portion back out is that correct??

    • Yes, because you have already received the tips in cash. If they didn’t deduct it back out, you’d be paid twice for the cash tips.