FAQ's: Tips, Service Charges, Automatic Gratuity, Etc.

Tips, Service Charges, Automatic Gratuity, Etc.

Ohio follows the IRS Guidelines around tip reporting as outlined by the IRS found here: https://www.irs.gov/businesses/small-businesses-self-employed/tip-recordkeeping-and-reporting

^The link above also outlines employer and employee responsibilities around tips and reporting.

In the most general terms:

• Employers have the right to add service charges (sometimes referred to as “automatic gratuity”) to checks.
• Funds collected from service charges belong to the employer (who can keep them or distribute back to employees): If distributed to employees, these funds are treated and taxed as non-tipped wages (for tax withholding and filing requirements).

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)
• Unclosed tab at close service charge

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.

Tips Are discretionary (optional or extra) payments determined by a customer that employees receive from customers. Tips 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, tip splitting, or other formal/informal tip sharing arrangements.

All cash and non-cash tips received by an employee are income and are subject to Federal income taxes. All cash tips received by an employee in any calendar month are subject to social security and Medicare taxes and must be reported to the employer.

Cash tips include tips received from customers, charged tips (for example, credit and debit card charges) distributed to the employee by the employee's employer and tips received from other employees under any tip-sharing arrangement.

If the total tips received by an employee during a single calendar month by a single employer are less than $20, then these tips are not required to be reported and taxes are not required to be withheld.

Tips also include tips received by both directly and indirectly tipped employees.

Reporting Tips and Directly and Indirectly Tipped Employees

Employees must report to their employer all cash tips received -- except for the tips from any month that total less than $20:

• Cash tips include tips received from customers, charged tips (for example, credit and debit card charges) distributed to the employee by his or her employer, and tips received from other employees under any tip-sharing arrangement
• Noncash tips (that is, tips received by an employee in any other medium than cash, such as passes, tickets, or other goods or commodities) from customers are not reported to the employer.

All cash tips and noncash tips should be included in an employee’s gross income and subject to federal income taxes.

Both directly and indirectly tipped employees must report tips to their employer.

A “directly tipped employee” is any employee who receives tips directly from customers, including one who, after receiving the tips, turns all of them over to a tip pool. Examples of directly tipped employees are waiters, waitresses, bartenders and hairstylists.

An “indirectly tipped employee” is a tipped employee who does not normally receive tips directly from customers. Examples of indirectly tipped employees are bussers, service bartenders, cooks and salon shampooers.

Employers 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.

For more information, including what to do if there are not enough wages to withhold all of the taxes, see Topic 761 - Tips – Withholding and Reporting.

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.