Updated: September 27, 2024
If you own a restaurant, bar, or any other small business where employees earn tips from customers, you have the added responsibility of withholding taxes from your employees’ paycheck, based on the tips they receive. There are special tax requirements for tips because they are often paid in cash. If calculating withholding taxes on tips sounds complicated to you, don’t worry: we’ve designed a calculator specifically to tackle tip tax.
All you have to do is enter into the calculator your employees’ gross wages, their W-4 withholding information below and the cash and credit card tips they’ve earned. The resulting calculation will tell you what the resulting withholding tax and net pay should be.
Tax and tip calculator: Try now!
Are there federal rules regarding tips?
Per Internal Revenue Service (IRS) guidelines, each month by the 10th of the following month, your employees are required to report to you the dollar amount of cash tips they receive (ideally, you’ll have credit card tip numbers in your accounting system already). And, as long as they earn more than $20 in tips per month, you are required to take out withholding tax.
Why do tips get taxed?
Simply put, the IRS considers tips to be income, so they are subject to federal income taxes such as Medicare and Social Security. However, should an employee receive tips during a single calendar month — by a single employer — that are less than $20, then these tips are not required to be reported and taxes are not required to be withheld.
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Related reading
After using this calculator and learning more about employer responsibilities surrounding tips, we have another resource that can be helpful. From obtaining your employer identification number (EIN) to maintaining payroll records, learn more about how to do your own payroll.
Should employees keep records of the tips they receive?
According to the IRS, employees are responsible for keeping a record of tips received from customers and providing a copy to employers. For recordkeeping, workers can use Form 4070a, or Employee’s Daily Record of Tips, or a similar log, and report the total amount of tips to their employer monthly.
What are the employer’s tip income obligations?
Uncle Sam says that employers must keep records of employee tip income that is reported to them. Why should employers have this on their to-do list? This is important because they will use the tip records to calculate the proper amount of income taxes and the employee’s share of Social Security tax and Medicare tax from the employee’s wages, including tip income, and deposit this tax on behalf of the worker.
Also, employers are required to pay the employer share of Social Security and Medicare taxes, which is based on the total wages paid to tipped employees as well as the reported tip income. In turn, this information and tax are reported to the IRS on the appropriate forms by the employer.
Keep in mind
Forgetting or neglecting to report cash tips doesn’t relieve your employee of the responsibility of paying taxes on them. Since tax evasion probably isn’t on anyone’s mind, keeping tax reporting on tips as easy as possible is a win-win for everyone so you can withhold the right amount of taxes from their hourly or salaried base wages. To keep things simple for you as the business owner, we recommend using a tax tip calculator like this at the top of this page to make sure you’ve got your withholdings correctly calculated. You can also find restaurant payroll software that makes it easier to automate the process, including submitting all tax filings.