Withholding on Tips

All tips are subject to federal income tax.

Cash tips of $20 or more received in any month are considered wages for federal income tax withholding and FICA purposes, while noncash tips are not.

In general, an employee who receives cash tips of $20 or more in one calendar month must report these tips to the employer on or before the 10th day of the following month. These reported tips are considered to have been paid by the employer in the same manner as wages, and for withholding purposes, they're treated as received by the employee when reported to the employer.

Therefore, the employer must make tax deposits, report the tips on the businesses’ tax return, and report the tips in boxes 1, 5, and 7 of the employee's Form W-2.

When the employer adds a mandatory fixed charge to the customer's bill in lieu of tipping (and distributes such service charge to the employee), such amount is not a tip but is considered part of the employee's regular wages.

The IRS has issued guidance clarifying that service charges cannot be treated as tip income and explaining the factors to consider in determining if payments to employees qualify as tips instead of service charges that are treated as regular wages.

The characteristics of a tip include the following factors:

• 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 negotiation or dictated by employer policy.
• 4. The customer generally has the right to determine who receives the payment.

If you have any questions about withholding on tips and service charges, please contact us.