1099 Tax Software Blog

Food and beverage establishments with employees who customarily receive tips can claim a ‘tip credit’ against Social Security and Medicare (FICA) tax payments made on behalf of employees.  Using Form 8846, the employer could list tip amounts, and claim a credit for employee tip income that exceeded the minimum wage for that locale.  For example, if there were an amount of $250 that exceeded the calculated minimum wage for hours worked, then the FICA tip credit would be $250 x 7.65% or $19.12 for the pay period.  This can add up significantly for an employer with many staff receiving tips, but even so many employers fail to take the credit each year.

The rationale behind this credit is that the employer did not receive any accrued benefit from the tips, and also did not make the decision on how much to tip an employee for each meal.  Therefore, their employer FICA payment responsibility only extended to the minimum wage equivalent, and no more.  However, automatic gratuities are set by each employer for their business, and that difference has brought about a rule change from the IRS.

Automatic Gratuities No Longer Are Included on Form 8846

A new rule from the IRS that classifies automatic gratuities on large parties will affect this tip credit.  Those automatic gratuities are now classified as “service charges” as discussed in this article: (LINK TO FIRST ARTICLE ON AUTO GRATS).   Service charges are now no longer classifieds as tip income and instead are included as regular wages, and cannot be claimed for the tip credit along with normal gratuities.  Obviously, this directly affects the amount of taxes employers pay each year, since the credit will be reduced.

One effect of this new rule will be to raise the amounts of FICA paid by employers for Social Security and Medicare.  Those employers who received a FICA Tip Credit to offset their portion of FICA payments, will now be paying additional FICA on any automatic gratuities, even if the amounts exceed the minimum wage.  This effectively raises their tax burden in addition to the increase in wages that would need to be paid.

The only way to avoid this rule change is to eliminate automatic gratuities for large parties, and instead allow customers to tip a “suggested amount”.  It is unclear why the IRS implemented this rule change with regard to automatic gratuities, except for the reason that those amounts were being fixed by the employer as part of employee compensation.  In any case, the rule is forcing some food and beverage establishments to change their policies on automatic gratuities, which may be more of a burden for employees who will not be assured of a fixed percentage tip on large parties.

If it weren’t for cash tips, many restaurant and bar employees would have trouble making ends meet. As for any other type of income, the Internal Revenue Service wants its cut. This means that all employees who receive $20 or more a month in tips must report all of the tip money to their employers. Employers report these tips through IRS Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.

Requirement to File

You will file Form 8027 if you own a large food or beverage establishment. If you own more than one establishment, you’ll have to file a separate form for each one, even if they operate in the same building. If you have to file multiple 8027s, then you’ll also have to file a copy of Form 8027-T, Transmittal of Employer’s Annual Information Return of Tip Income and Allocated Tips.

How do you know whether your food or beverage establishment falls under the filing requirements? Here are the applicable rules:

Your business serves food and/or beverages that is consumed at the establishment

Customers normally tip for service

On a typical business day, you employ more than 10 employees who work more than 80 hours

If that last requirement has you scratching your head, all you must do is figure the average number of employee hours worked on a typical business day within your busiest and least busy months of the year. Divide that by the number of days opened during those two months, and if the result is greater than 80 hours, then the rule applies to you. If your establishment is new, use two consecutive months to figure the average hours.

When you figure the number of employees, include those that don’t receive tips, such as cooks and cashiers. By the way, you can use online software to help you figure your employees, prepare your Form 8027 and file it for you electronically. The software can import external Excel or CSV data, and the provider will even prepare the form for you.

Avoid Penalties

You must file your Form 8027 by the end of February, but if you file electronically, you have until the end of March. If you need an extension of time, file Form 8809.

You must allocate tips to employees that receive tips if your reported tips are less than a certain percentage (usually 8 percent) of your gross receipts for the month. You must also supply a Form W-2, Wage and Tax Statement, to each employee who receives allocated tips. The form must include the amount of tip money allocated to the employee.

Failure to file Form 8027 and W-2s in a timely manner can result in IRS penalties.

Large food or beverage establishments are required to file Form 8027 to report tip income and allocation of tips to employees. Not all food and beverage establishments are required to file Form 8027. For example, you do not need to file an 8027 if your business was only in operation for one month in 2012. However, if your establishment meets all of the following criteria then you must file Form 8027 between February and April during the tax season:

1      Food or beverages are served with the intention of consumption on the premises.

2      Tipping is a customary part of the service.

3      More than 10 employees who work 80 hours or more are normally employed on a typical business day.

The majority of food or beverage establishments meet the first and second criteria on the list, but its the third qualification that is the concerning issue for most owners. All employees count toward the 10 employee requirement even if they do not regularly receive tips as part of their job function such as cooks and kitchen help.

There is a worksheet to help determine if you had more than 10 employees working on a typical businesses because you can still qualify with less than 10 employees. Please note that If you own more than one food or beverage establishment you must fill out Form 8027-T instead to itemize the receipts of each individual establishment.

What information is reported and filed on Form 8027?

The top part of the form contains fields as to the basic information about the establishment including the name, address and employer identification number. The Employer’s name and address information as shown on Form 941 is also required. To the left, you see a choice of 4 types of establishments. Only check one box that best describes your business: evening meals only, evening and other meals, meals other than evening meals or alcoholic beverages.

As you move through the form, lines 1-2 deal with credit charges specifically, the tips on credit charges and the gross receipt totals with tips respectively. Line 3 should reflect the total amount of service charges added to a customer bill that was then allocated to employees as part of their wages.

The subsections of line 4 are really the crux of Form 8027 and reflect the total amount of reported tips by indirectly and directly tipped employees. Indirectly tipped employees receive tips from other employees instead of customers such as cooks and bussers. A directly tipped employee receives tips from the customers such as bartenders and waitstaff.  Regardless of the source, any employee who earns $20 or more in tips on a monthly basis must report all tips to the employer. Add the amounts on lines 4a and 4b to calculate the total tips reported for the year.

On line 5, report the summation of the gross receipts for all food or beverage operations. Some things to consider when determining your gross receipts include cash sales, charge receipts and the retail value of complementary food or beverages if a tip was calculated based on the sale of that item.

Multiply the amount on line 5 by .08, unless you have been granted a lower rate by the IRS, and write this amount on line 6. Now compare the amount on line 6 with the amount on line 4c. If line 6 is less than lince 4c then your calculations for this form are complete. However if line 6 is more than line 4c, proceed to line 7 to allocate tips to employees.

Which calculation method is best to allocate tips to employees?

You have three options if you are required to allocate tips to employees: the hours-worked method, gross receipts method or good-faith agreement method. The hours-worked method simply distributes the tips to each employee based on the number of hours worked. Regardless of amounts earned, the employee who worked the most receives the largest allocation and so on down the line.

The gross receipts method is based on the amount of sales by each employee instead of the amount of hours worked. As a result, high performance employees with many sales receives the largest allocation regardless of hours worked.

The good-faith agreement method allows you to work out a custom arrangement based on circumstances of your particular establishment. The agreement is validated when two thirds of the staff agrees and signs the document. You must attach a copy of the agreement to Form 8027 if you select this option.

The result of your calculations are listed on each employee’s W-2 in box 8 to be reported as part of their individual wage. As a result, you should judge each allocation method on its fairness to your employees with regard to your particular situation.