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Automatic Tip Charges for Large Parties in Restaurants: New Classification as “Service Charges” Not Reported on Form 8027

October 23rd, 2014 No comments

In January of this year, the IRS changed a long-standing rule on automatic gratuities in restaurants for large parties.  Typically for parties of 6 or more guests, a restaurant will charge an automatic 18 to 20 percent to make sure that the gratuity is adequate to compensate the server.  These automatic tips have always been viewed for tax purposes the same as any tips for wage and tax purposes.  Any food and beverage employer with more than 10 employees reports all tips on Form 8027 each year.  The new IRS rule now includes these large party gratuities as “service charges”, classifying them as simple wages rather than tips, affecting reporting for both the employee and employer.

Service Charges as Regular Wages and Not Tip Income

Historically, tip income is used to offset the amount of minimum wage paid to employees.  Since the automatic gratuities will now be seen as service charges, that means that employers will not get a “tip credit” for those amounts to offset minimum wages paid to wait staff.  This could raise their labor costs by requiring more wages to be paid to staff, even while the employee receives the same amount of tips.  Another employer burden is where a single waitperson serves both large and small parties in the same shift.  In that case, the tips received would have to be allocated based on party size, as well as the hourly rate paid to the employee.  The only real solution would be to designate some wait staff as “only large party” employees for the shift.

Reporting Automatic Gratuities as Service Charges

The employer reports tip income on Form 8027, based on all cash tips disclosed by the employee, as well as those on credit slips.  The automatic gratuity “service charge” would now be reported as wages only and not included on Form 8027.  The service charges would now be reported on Form W-2 as regular wages to the employee.  This removes the automatic gratuities from the 8% computation of allocated tips on Form 8027 based on gross receipts, which is the IRS baseline to make sure that all tip income is reported and taxed.  This is a complex computation made more so by the new rule on automatic gratuities.

The approach by many restaurants to this new rule has been to eliminate the automatic gratuity on large parties, and only “suggest” tip amounts to customers.  While this seems to eliminate the tax and reporting burden, it does place the wait staff at risk of receiving lower gratuities from customers who are no longer bound by mandatory tip amounts.

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Reporting Cash Tips

July 3rd, 2014 No comments

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.

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What is Form 8027 and Who Needs to Submit One?

June 11th, 2013 No comments

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.

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