Tips on Tips. Legal and Tax Issues Regarding Tips. Marney Zellers, CHAE Hospitality Specialist. June 25, 2014

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1 Tips on Tips Legal and Tax Issues Regarding Tips Marney Zellers, CHAE Hospitality Specialist June 25, 2014

2 Tips on Tips Overview Tips vs. Service Charges Tip Pools and Tip Sharing Tip Reporting and Tip Income Audits Best Practices

3 Tips on Tips Internal Revenue Code History 1965: IRC requires employers to withhold FICA tax on tips from employees pay, but employers did not have to pay a matching amount 1982: IRC requires employers whose employees fail to report at least 8% of gross sales as tips to allocate tips to this level 1993: FICA tip credit enacted - employers allowed a tax credit for the FICA taxes paid on their employee tips 2002: Supreme Court rules the IRS can determine the amount of tips it thinks employees should have reported based on restaurant data and can assess the employer share of FICA tax on suspected unreported tips 1977: IRC requires employers to pay its share of FICA tax on tips, but only up to the minimum wage 1987: Congress amends IRC to require employer portion of FICA tax on all tips 1993: IRS introduces the Tip Rate Determination/Education Program (TRDEP) to encourage employees to report the correct amount of tip income to their employer. 2013: IRS enforces Revenue Ruling , clarifying their distinction between tips and service charges and their treatment of each

4 Tips on Tips Tips vs. Service Charges QUESTION Service charges differ from tips in the following way: a) Tips are subject to the employer matching FICA tax but service charges are not. b) Tips can be considered toward minimum wage in states with a tip credit while service charges may not. c) Service charges belong to the employer while tips belong to the employee. d) All of the above.

5 Tips on Tips Tips vs. Service Charges Tips vs. Service Charges - Defined Tips Service Charges Payment is free from compulsion Customer has unrestricted right to determine amount Generally, the customer has the right to determine who receives the payment Payment is required Amount is determined by someone other than customer Someone other than the customer determines who receives the payment

6 Tips on Tips Tips vs. Service Charges Tips vs. Service Charges - Treatment Tips Service Charges Reported to IRS as tip income and eligible for the Reported to IRS as wages and not eligible for the FICA tip credit FICA tip credit Legally belong to the person for whom the Legally belong to employer. Treated as income and customer intended payment. Employer distribution subject to sales tax in applicable states. Employer of tips to those other than said person are limited. retention and distribution of payments more liberal. Count toward meeting minimum wage requirement Count toward meeting minimum wage requirement in states with tip offset (tip credit) in states with tip offset (tip credit) Included in hourly rate used to determine overtime rate

7 Tips on Tips Tips vs. Service Charges Commonly referred to as Auto Grat AUTOMATIC GRATUITY Commonly added to restaurant checks of larger parties Automatic gratuity policies are commonly written on menus and verbalized by front desk staff IRS Rev. Ruling declares auto grat to be a service charge, not a tip

8 Tips on Tips Tip Pools and Tip Sharing QUESTION A reasonable tip pool, according to the US Dept. of Labor, includes the following: a) Employers may require directly tipped employees to share service charges such as auto gratuity, but not discretionary tips. b) Employer may require directly tipped employees to share up to 15% of all their tips with other employees involved in the service of the customers c) Salaried managers may be included in a tip pool as long as they are directly serving the customers d) None of the above

9 Tips on Tips Tip Pools and Tip Sharing Tip Pools and Tip Sharing Definitions Tip Pool Tip Share All tips collected and distributed by house Tipped employee required to share a percentage of tips with other employees

10 Tips on Tips Tip Pools and Tip Sharing Mandatory Tip Pools and Tip Sharing Who Can and Cannot Partake Can Cannot Food and beverage servers (waiters, waitresses, cocktail servers) Bartenders Owners or managers Cooks or chefs Bussers and bar backs Hosts and greeters Counter personnel Bellhops Dishwashers Laundry room attendants Janitors The house Some hourly supervisors Some sushi and teppanyaki chefs

11 Tips on Tips Tip Pools and Tip Sharing Tip Pools and Tip Sharing Department of Labor Rules and Regulations Permissible as long as the employees sharing in the tips have somehow participated in serving of the customers who left the tips Legally belong to the person for whom the customer intended payment. Employer distribution of tips to those other than said person are limited. Count toward meeting minimum wage requirement in states with tip offset (tip credit). Employer may only take a tip credit for the amount of tips each employee ultimately receives. Employer must notify its employees in advance of any required tip pool contribution amount. Employer may not retain any of the employees' tips for any other purpose. Department of Labor tip pool/tip share rulings do not apply to employer mandated service charges.

12 Tips on Tips Tip Pools and Tip Sharing Tip Pools and Tip Sharing The Mario Batali Case STEPHANIE CAPSOLAS, et al v. PASTA RESOURCES, INC., et al Class action lawsuit claiming employees were required to tip out 4-5% of wine sales to support the wine program. Employees claimed the proceeds went to the house. The judge agreed. Batali s group agreed to pay $5.25 million in restitution.

13 Tips on Tips Tip Pools and Tip Sharing Tip Pools and Tip Sharing Cumbie v. Woody Woo and Oregon Restaurant Association et al v. Solis Ninth Circuit Court of Appeals Jurisdiction includes California, Nevada, Washington, Oregon, Alaska, Idaho, Montana, Hawaii, and Arizona An employer can require servers to pool their tips with non-tipped kitchen and other back of the house staff, so long as a tip credit was not taken and the servers were paid minimum wage. In 2011, the DOL issued regulations that directly conflicted with the holding in Woody Woo. As a result, employers could no longer require mandatory tip pooling with back-of-the-house employees. Shortly after the 2011 regulation, the National Restaurant Association, Washington Restaurant Association, Oregon Restaurant and Lodging Association, and Alaska Cabaret, Hotel, Restaurant, and Retailer Association filed a law suit in the US District Court. On June 10, 2013, the District Court granted the plaintiffs summary judgment motion, holding that the DOL exceeded its authority by issuing regulations on tip pooling in restaurants. The District Court stated that the language of the FLSA is clear and unambiguous; it only imposes conditions on employers that take a tip credit. Final implications are still not clear. Employers of non-tip credit states are still advised to act cautiously around tip pools involving back of the house staff.

14 Tips on Tips Tip Reporting and Audits QUESTION When declaring tip income, the IRS requires an employee report: a) At least 8% of the employee s total sales b) 10% of the employee s total sales or 100% of credit card tips, whichever is higher c) 100% of credit card tips plus 10% of the employee s cash sales d) None of the above

15 Tips on Tips Tip Reporting and Audits Tip Reporting - Requirements Employee Keep a daily record of tips and sales Employee who receive $20 or more in tips, either directly or indirectly, in a month must report all tips to the employer by no later than the 10th day of the following month. (Employers may require employees to report tips more often.)

16 Tips on Tips Tip Reporting and Audits Collect employee tip reports Tip Reporting - Requirements Employer Withhold and pay Social security, Medicare and federal income taxes on all employee tips Employers must match employee s Social Security and Medicare taxes on all employee tips (NOTE: this is true whether or not the employee reports the tips) When preparing an employee's Form W-2, include wages, tips and other compensation in the box labeled "Wages, tips, other compensation." Include Medicare wages and tips, and social security tips in their respective boxes. When figuring the employer's liability for federal unemployment tax, add the reported tips to the employee's wages. Allocate tips to any directly tipped employees who reported tips of less than 8% of his or her sales. File Form 8027 if tipping is customary, food and drink are provided for consumption on premises and the business employs more than 10 employees or the equivalent (more than 80 employee hours per day) on a typical day.

17 Tips on Tips Tip Reporting and Audits Tip Reporting - Forms Form Purpose/Requirements Employer s Quarterly Federal Tax Return (for payroll taxes) Employer's Annual Information Return of Tip Income and Allocated Tips (employers with 10 or more employees who work 80 hour or more in a typical day) Social Security and Medicare Tax on Unreported Tip Income (for employees to report and pay uncollected taxes if regular pay was not enough for employer to withhold all the taxes owed, or on allocated tips) 4070 Employee s Report of Tips to Employer

18 Tips on Tips Tip Reporting and Audits QUESTION TRUE or FALSE In a tip income audit, the IRS focuses solely on recovering income tax from employees who underreport their tip income.

19 Tips on Tips Tip Reporting and Audits Tip Audit Facts The IRS has the right to audit at least as far back as three years - further, if the agency believes it's a case of fraud. Some restaurant servers have even been jailed for tax evasion. Courts continue to hold that the IRS may use indirect and aggregate methods for determining underreported tip income in audits where employee tip reporting records are incomplete or in employer-only audits. In an employer-only audit, the determination is made through an observation that the overall rate of tips for a restaurant is not high enough. Audits are made without auditing the employees of the restaurant. Along with requiring employers to pay their share of FICA taxes on underreported tip income, the IRS may also assess penalties to employers equal to the EMPLOYEE portion of FICA taxes.

20 Tips on Tips Tip Reporting and Audits Triggering a Tip Audit Red Flags Percentage of total reported tips relative to total sales is below industry average Credit card tips reported on form 8027 exceed total tips declared to employer by employees Percentage of reported cash tips relative to cash sales is significantly lower than that of credit card tips to credit card sales

21 Tips on Tips Tip Reporting and Audits Tip Rate Determination/Education Program (TRDEP) Program Summary TRDA (Tip Rate Determination Agreement) Restaurant specific IRS works with employer to determine tip rate for each job classification Requires at least 75% of employees to sign a Tipped Employee Participation Agreement (TEPA) and report at or above the determined rate Employer provides IRS with name, SS#, sales and tips reported, etc. of employees who do not comply Protects employer from prior period audits

22 Tips on Tips Tip Reporting and Audits Tip Rate Determination/Education Program (TRDEP) Program TRAC (Tip Reporting Alternative Commitment) Summary Employer must establish a quarterly education program for existing employees and educate newly hired employees about their tip-reporting responsibilities. Employer must file all appropriate returns and make timely tax deposits to be in compliance. Employers with more than 10 employees (80 work hours per week) must file Form Adequate records must be maintained and made available to the IRS. Complying employers will not be subject to employer-only audits.

23 Tips on Tips Tip Reporting and Audits Tip Rate Determination/Education Program (TRDEP) Program Summary emtrac (Employer-Designated TRAC) Same requirements and advantages as TRAC More flexible than a TRAC. Employer develops and submits for IRS approval a tip education and reporting program for their employees.

24 Tips on Tips Best Practices Problems and Solutions Issue Best Practices Auto gratuity is common in your business. Reduced FICA tip credit would have a major impact on business. Employees underreport tips Want to include kitchen staff in tip pool Consider reducing use of auto gratuity and printing suggested tip amounts on guest checks Retain a portion of the auto gratuity for the house Strong policy including tip allocation policy Tip reporting training and education Tip Agreements (TRDA, TRAC, emtrac) Voluntary tip pool Service charge instead of tip

25 Tips on Tips Final Tips Know the difference between tips and service charges and maximize the advantages of each Structure fair and compliant tip pools and tip sharing agreements Understand your tip reporting and withholding responsibilities Avoid tip income audits through education and solid employee requirements

26 Tips on Tips LET S HEAR FROM YOU Questions? What are your experiences and best practices?

27 The material appearing in this presentation is for informational purposes only and is not legal or accounting advice. Communication of this information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although these materials may have been prepared by professionals, they should not be used as a substitute for professional services. If legal, accounting, or other professional advice is required, the services of a professional should be sought.