If you have employees who receive tips of $20 or more in a calendar month while on the job, they are required to report to you the amount they receive. They must give you a written report by the tenth day following the month they received the tips. Although employees who receive less than $20 per month are not required to report the tips to you, they must include them in gross income on their tax return.

Tips that employees receive directly from customers and tips that customers charge to their bills must be reported. Service charges added to a bill and paid to employees are not considered tips. These charges are regular wages.

Employees can use Form 4070-A to keep a daily record of their tips and Form 4070 to report their tips to you. Both of these forms are in Publication 1244, Employee's Daily Record of Tips and Report of Tips to Employer.

When you receive the tip report from your employee, use it to figure the social security, Medicare, and income taxes to withhold for the pay period on both the wages and reported tips. You can collect these taxes from the employee's wages or from other funds the employee gives you. If you don't have enough employee funds to collect all the tax, apply them in the following order. First withhold from the wages all taxes due on the regular wages, then withhold from the balance of the wages taxes due on the reported tips. Social Security and Medicare tax on reported tips will be withheld before any income tax. Any remaining unpaid taxes should be collected from the next paycheck. If you cannot collect all of the employee's social security and Medicare taxes on tips, show the uncollected amount on the employee's Form W-2, and also as an adjustment on your Form 941, Employer's Quarterly Federal Tax Return. The employee must pay the taxes with his or her income tax return.

The Form W-2 you provide to your employee will include tips reported to you in the wages, tips, and other compensation box, include tips in the box for Medicare wages and tips box, but for social security purposes, show the tips separately in the box for social security tips.

When figuring your liability for federal unemployment tax, add the reported tips to your employee's wages.

If you operate a large food or beverage establishment where tipping is customary and you normally employ more than ten people on a typical business day, you must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, each calendar year. If you have more than one food or beverage operation, you have to file a separate Form 8027 for each. Form 8027 is due on the last day of February of the next year and is filed with the Internal Revenue Service Center, Andover, Massachusetts, 05501.

If the total tips reported by all employees are less than eight percent of your gross receipts, you must allocate the difference among the employees who received tips. The allocation may be based on each employee's share of gross receipts or share of total hours worked, or on a written agreement between you and your employees. Show the amount allocated on the employee's Form W-2. Employees should not report the allocated tip amount in gross income if their records show they received a different amount. The employer should not withhold income, social security, or Medicare taxes on allocated tips. Any incorrectly withheld taxes should be refunded by you to the employees.

If you are required to allocate tips, your employees must continue to report all tips to you, and you must use the amounts they report to figure payroll taxes.

For more information order Publication 15-A, Employer's Supplemental Tax Guide; or Publication 531, Reporting Tip Income by calling 1-800-829-3676.

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