Do your employees receive tips? As tips are becoming more common in businesses other than just restaurants, business owners need to make sure not only is the employee doing their part in recording their tips properly, but the employer as well. Tips come in a couple of different forms and employers need to be aware of how the tips were received by the employee to make sure they are reported properly.

Cash Tips

Customers hand cash to the server, housekeeper, barista, etc. and that employee keeps those tips. At the end of the employee’s shift, they are required to tell the employer the amount of cash tips received for that shift. Employers are to report cash tips on the employee’s paycheck as gross earnings and deduct them from net pay since those monies were already received by the employee. The employee will pay their share of payroll taxes this way, and the cash tips will be included on their W-2 at year end.

Credit Card Tips

If customers leave tips on credit cards, there are a couple of ways those get paid to employees. Some employers take cash out of the till at the end of the day in the amount of those credit card tips and hand the cash to the employee. If that is the case, then those tips would be treated as cash tips as stated above. If an employer totals the credit card tips for the whole pay period and pays them out through payroll, then those tips go into gross earnings and are added to the employee’s net check after taxes are calculated.

In some states, like South Dakota, the state minimum wage is $11.20, but for tipped employees like servers and bartenders, the state minimum wage is $5.60. It is assumed the tips received will increase the employee’s earnings to at least $11.20 per hour. Most tipped employees do make at least, if not more than, minimum wage during their shift, but employers need to confirm that based upon the hours worked that their employees earn enough.

Examples:

Employee A works 10 hours at $5.60 per hour and earns $100 in tips. Total gross earnings are 10 hours x $5.60 = $56, plus $100 in tips = $156 in total gross earnings. Divide the gross earnings of $156 by the 10 hours worked and the employee made $15.60 per hour, which exceeds the $11.20 per hour requirement.

Employee B works 10 hours at $5.60 per hour and earns $50 in tips. Total gross earnings are 10 hours x $5.60 = $56, plus $50 in tips = $106 in total gross earnings. Divide the gross earnings of $106.00 by the 10 hours worked and the employee made $10.60 per hour, which is less than the required $11.20 per hour. In this case, the employer would need to increase the employee’s gross earnings by $6 to make $112 total gross earnings or $11.20 per hour earned.

In Employee B’s example, their employer has to add $6.00 to ensure the employee is paid minimum wage. That amount is typically shown as a separate pay item as “Tip Make Up” or something similar, to differentiate it from the other pay items.

Each state has different minimum wage requirements and researching the rules in the state the employee is working is encouraged. Regardless of the state rules, minimum wage must be paid. For businesses with tipped employees, it is beneficial to ask about the Tip Credit that is available on the business tax return. Look for more information on that credit in a future KT Addition or on KT’s blog.

The payroll team at KT can assist with questions on how to properly report tips as well as any other payroll questions you may have.