Tips vs Service Charges: An IRS Reminder

The IRS wants to make sure that employers understand tax ramifications of the various payments that they make to employees or that their employees might receive.  So the IRS has posted a reminder for employers when it comes to tips verses service charges.  The key difference between the two categories affect the taxation for employees as well as the reporting. So-called “automatic gratuities” and any amount imposed on the customer by the employer are service charges, not tips.  Service charges are generally wages, and they are reported to the employee and the IRS in a manner similar to other wages. On the other hand, special rules apply to both employers and employees for reporting tips. Employers should make sure they know the difference and how they report each to the IRS.

What are tips? Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers. They include:

  • Cash tips received directly from customers.
  • Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
  • The value of any noncash tips, such as tickets, or other items of value.
  • Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangements.

Four factors are used to determine whether a payment qualifies as a tip. Normally, all four must apply. To be a tip:

  • The payment must be made free from compulsion;
  • The customer must have the unrestricted right to determine the amount;
  • The payment should not be the subject of negotiations or dictated by employer policy; and
  • Generally, the customer has the right to determine who receives the payment.

If any one of these doesn’t apply, the payment is likely a service charge.

What are service charges? Amounts an employer requires a customer to pay are service charges. This is true even if the employer or employee calls the payment a tip or gratuity. Examples of service charges commonly added to a customer’s check include:

  • Large dining party automatic gratuity
  • Banquet event fee
  • Cruise trip package fee
  • Hotel room service charge
  • Bottle service charge (nightclubs, restaurants)

Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages to those employees.

All cash tips and noncash tips should be included in an employee’s gross income and subject to federal income taxes.ployers are required to retain employee tip reports, withhold income taxes and the employee share of Social Security and Medicare taxes from the wages paid, and withhold income taxes and the employee share of Social Security and Medicare taxes on reported tips from wages (other than tips) or from other funds provided by the employee. In addition, employers are required to pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as the reported tip income.  Employers must report income tax and Social Security and Medicare taxes withheld from their employees’ wages, along with the employer share of Social Security and Medicare taxes, on Form 941, Employer’s Quarterly Federal Tax Return, and deposit these taxes in accordance with federal tax deposit requirements.Tips reported to the employer by the employee must be included in Box 1 (Wages, tips, other compensation), Box 5 (Medicare wages and tips), and Box 7 (Social Security tips) of the employee’s Form W-2, Wage and Tax Statement. Enter the amount of any uncollected social security tax and Medicare tax in Box 12 of Form W-2. See the General Instructions for Forms W-2 and W-3.

Reporting Service Charges: Employers who distribute service charges to employees should treat them the same as regular wages for tax withholding and filing requirements, as provided in Publication 15, Employer’s Tax Guide. Distributed service charges must be included in Box 1 (Wages, tips, other compensation), Box 3 (Social Security wages), and Box 5 (Medicare wages and tips) of the employee’s Form W-2.

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White Paper for the Month: Educational Assistance

My white paper for September is on educational assistance.  How to properly track and tax this benefit is paramount to ensure compliance.  Hope you find it useful.

white-paper-educational-assistance-2016

Beginning in October we will go back to more frequent white papers.  We do them monthly during the summer as it is usually a slow time of the year for payroll and we all want to enjoy the summer off.  But as year end begins to approach we will be focusing our white papers on preparing for it.

Speaking of year end…don’t get left out in the cold when it comes to critical year end news updates. Subscribe to The Payroll Pause today. Get all the latest payroll news as it is released, including wage bases, rates, and annual updates for the low price of only $149 per year.  This type of news update service usually costs payroll departments $500 or more per year.  But payroll news should not be out of the reach of all payroll professionals.

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White Paper: Disaster Payments and the IRS

We are always hearing in the news about the latest disaster in the nation. Whether it be wild fires in California or flooding in Texas. Natural disasters do happen and can be annual occurrences in some parts of the nation.  When this happens, it is natural to want to help those individuals who are personally affected especially if it strikes close to home like in the case of a co-worker.  When a co-worker loses a home to a wild fire or must move out due to flood damage even employers want to help out.  But when an employer wants to help, does that change the nature of the disaster grantassistance. In other words,  if co-workers take up a collection it is one thing, but what if the employer gives the employee a grant to help cover the costs not reimbursed by insurance? Is it then taxable income and taxes must be deducted? Actually, it may not have to be. Our white paper this time is on Handling Disaster Relief Payments in Payroll.  It explains how and when these types of payments can be made and the taxation requirements.  We hope you find it useful.

white paper disaster payments 2016

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White Paper: If I use the gym is it taxable?

Our latest white paper deals with athletic facilities.  It is very common for employers to offer wellness programs to get or keep employees fit and healthy.  Employers may offer the use of an onsite athletic facility or they may purchase gym memberships outright or subsidize a portion of the annual fee.  No matter what is offered the taxability has to be determined to ensure compliance. It basically boils down to is the gym onsite or off.  Onsite athletic facilities are normally nontaxable if the employee can use it before work, during work or after work.  Memberships purchased outright or even subsidized are generally taxable income to the employee.

white paper athletic facilities 2016

This Week’s White Paper–Employee Achievement Awards

Taxing awards to employees is always a tricky business.  Is it taxable or not?  If I take taxes out will that diminish the award or the employee’s moral over receiving it? Unfortunately, we sometimes can’t take that into consideration.  The IRS says it is taxable, so we tax.  But sometimes the IRS says it is not taxable.  Case in point, employee achievement awards. Given for length of service or safety, these awards can be given without adding it as income to the employee’s wages if done correctly. Of course, no cash or gift certificates. It must be tangible personal property like a pin for years of service or a plaque for safety.  Our white paper this week deals with when to tax and when not to tax employee achievement awards. We hope you find the information useful.  You can request your copy of our white paper on our website.

 

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Company Cars Part 2

Our free white paper this week is the second of our two-parter on the personal use of a company car.  This time we are doing the math.  Yes unfortunately, math is involved when having to determine the taxable wages.  But it is not the only thing needed to do the computations. Vehicle values and vehicle logs are also needed, depending on the method chosen.  You also need to determine the proper method based on the value of the car and the status of the employee.  We hope you find the white paper useful. It can be requested on our website.

 

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Taxation of Wellness Programs

The Office of Chief Counsel of the Internal Revenue Service has issued a memorandum on “Tax Treatment of Wellness Program Benefits and Employer Reimbursement of Premiums Provided Pre-tax Under a Section 125 Cafeteria Plan”.  Not quite a catchy title I admit but it does contain guidance that is useful.  The two questions  that were at issue are as follows:

  1. May an employer exclude from an employee’s income under section 105 or section 106 cash rewards paid to an employee for participating in a wellness program?
  2.  May an employer exclude from an employee’s income under section 105 or section 106 reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a section 125 cafeteria plan?

The conclusion reached by the Chief Counsel was no on both counts. 1. An employer may not exclude from an employee’s gross income payments of cash rewards for participating in a wellness program. 2. An employer may not exclude from an employee’s gross income reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a section 125 cafeteria plan.

For those of you who need to research this closer I included the link to the memorandum issued on April 14, 2016 and released on May 27, 2016.  They review three different situations and then provide the law and analysis you may need if this affects any benefits you are offering.

 

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