Tipping is vital in the service industry as a way to incentivize quality customer service — but it’s often mishandled. And that’s more serious than many employers might think.
Some business owners are putting their businesses at risk by not paying the required amount of tax on the tips their employees receive. And even if they are paying taxes, it’s often up to busy managers to calculate tips correctly, which can be a complex process.
Business owners need a better understanding of how to manage tips in compliance with state and federal regulations. In this article, we’ll explain how tips work, how they can contribute to the hourly pay of your employees, and when to pay taxes on them. We’ll also discuss rules for tipping management staff, whether pooling tips is a good idea, and how Homebase can help you make tipping work for your business.
At a glance
- How do tip credits work?
- How tips affect total wages
- When to pay tax on your tips
- How to pay tips to employees
- Why a Point of Sale (POS) system will make your life easier
- Our key takeaways on tipping
How Do Tip Credits Work?
In a tip credit system, business owners can allocate a part of a staff member’s tips to meet the national minimum wage requirements. Employers use tip credits in industries where workers earn most of their money from tips. This system aims to strike a balance between fair compensation for employees and the economic realities of the service industry. And while it’s beneficial for employers, there are regulations you’ll need to follow to protect both you and your staff.
For example, according to The Fair Labor Standards Act FLSA, the federal minimum wage is $7.25 an hour. But the employer’s contribution could be as low as $2.13 per hour providing that you can make up the $5.12 difference in tips.
This practice is only allowed when employees make more than the minimum wage from tips during a weekly or biweekly pay period, and it can become complicated.
That’s why Homebase’s payroll feature has a tip shortage calculation function that lets employers automatically supplement pay when employees don’t make enough in tips to meet minimum wage.
Rules on Tips Vary by State
Your first step should always be to find out the rules for your particular state. In states like California, employers have to pay minimum wage, and any tips are a bonus. On the other hand, states like New York offer a minimum wage of $15 per hour, with a tip deduction of $5. So even with the maximum $5 offset from tips, you’ll still be paying your staff $10 per hour.
How do Tips Affect Total Wages?
It’s important to remember that tips are not for salary-earning managers or owners, and, in a restaurant setting, they’re usually only for front-of-house staff. So in a bar with one owner, one bartender, and one manager, they’d go to the bartender only.
In a restaurant with many front-of-house staff, the tips would be for the cashiers, the bar workers, and the servers.
There are a few different ways business owners can approach tipping in their businesses. They’re most commonly paid directly to the employee who provides the service in cash or by credit card. In many cases, a gratuity line is included on the bill, allowing customers to write in a specific amount or percentage as a tip. Alternatively, customers can leave cash tips on the table or hand them directly to the server.
Additionally, some businesses keep a tip jar at the POS kiosk, and the front-of-house staff splits the contents at the end of a shift.
However, no matter the form that they come in, your employees are responsible for reporting any tips they earn to their employer. This should be in the form of a daily record, as required by the IRS.
To ensure employees are always getting paid the minimum wage, employers need to check the daily tip record against the hours every staff member works. That’s why it’s crucial to use a platform like Homebase to accurately track employee work hours.
Our free time clock app makes this process easy: Team members simply clock in when it’s time to start their shift, and Homebase automatically converts their hours into timesheets you can review at the end of every work day.
Is a Service Charge the Same as a Tip?
Service charges and tips follow different rules. A tip — or gratuity — is the money that goes straight to the employees and can form part of their hourly pay. A service charge, however, is an additional payment for the business or establishment, and not specifically for the staff. So for example, if you have a 10% service charge that is added to a customer’s bill automatically, this isn’t a tip, but a part of the cost of your service.
Business owners can do what they like with a service charge. They can share with staff as part of their pay, but they’re under no obligation to do so. Owners also have to pay tax on the money they receive as a service charge, just like their other income.
When to Pay Tax on Your Tips
If an employee makes $20 or more in tips for a given month, they have to report those tips to their employer, and those tips must be taxed, according to the IRS.
To ensure you’re withholding the right amount of taxes and filing them to the right agencies, you’ll need employees to complete the right paperwork when they’re hired, including forms like the W-4 and W-2.
Remember that the easier your process is for recording tips, the less work and stress there will be for both you and your staff. We designed Homebase payroll to calculate owed payroll taxes for you, ensuring you’re withholding the right amount from employee paychecks, and filing taxes on time — all while minimizing errors and time spent.
Plus, our labor forecasting tool gives you the insights you need to streamline your employee schedule and reduce your labor costs.
Is Tip Pooling a Good Idea?
Tip pooling isn’t a bad idea, but it only makes sense in businesses where employees already make minimum wage.
Additionally, though it seems like a straightforward system to pool tips and split them between employees, remember that tips count as official income for team members. This means that the government requires them to pay Medicare and Social Security taxes on money earned from tipping, So when it comes time for them to report their tips to the IRS, tip pooling can make things a little difficult.
More than anything else, it’s vital to have set up a legally sound and well-organized tip system before employees start earning. By establishing a clear process for exactly how tips are divided, you minimize any potential for conflict, keeping your staff happy.
How to Pay Tips to Employees
You can issue tips to employees directly in cash or by credit card. Keep in mind that charge tips (tips paid by card) may have a fee, and you’ll need to deduct these fees when paying your staff. For example, a 5% card fee on a $10 tip means you pay your staff $9.50 in tips. And you’ll still have to ensure your staff gets paid the minimum wage. So if deducting a card fee from a tip drops their pay below minimum wage, you’ll need to make up the difference.
Either way, these tips must be reported and taxes must be paid for them by both employer and employee. One of the most common ways to receive tips is by credit or debit card payment, and this can be a blessing in disguise when it comes to your workload. Why? Because with a good tool, you can eliminate part of the work.
To avoid any errors, and save time, it’s best to make Homebase do the work for you. Homebase will help you calculate the exact amount to pay your staff based on the tips they’ve earned in any particular shift. You can also use it to calculate the total tips if you’re using a pooling system and ensure you’re distributing them fairly. That way, sorting out payroll, even when it fluctuates from week to week, doesn’t need to be a lengthy and painful process.
Best of all, employees can access up to $400 of their wages before payday with Homebase’s Cash Out function. This allows team members to handle unexpected expenses and emergencies, and it allows you to show your staff how much you care about them.
Use a Point of Sale System to Make Your Life Easier
Here’s the main philosophy behind Homebase’s POS Integrations: We know that the more efficiently you can organize shifts, payroll, and tips, the less admin you’ll have to deal with. A solid framework and automated processes mean less human error and more free time for you.
Homebase integrates with popular POS systems like Clover, Square, Shopify, Poynt, and Toast letting you seamlessly sync employee info so you can keep your accounts up-to-date and running smoothly.
You’ll be able to keep on top of tipping, payroll, and recording shifts and save time juggling spreadsheets and paper timesheets. Instead, you can keep your expense-related information stored neatly in one place, which helps you make better financial and staffing decisions for the future.
Our Key Takeaways on Tipping
- Check your state laws. States often have their own rules and regulations for tipping employees.
- Employees should report tips received at the end of each shift because they’re considered taxable income. The Homebase app simplifies tracking employee tips, shift to shift.
- Stick with a POS system that syncs with payroll. This makes accounting for credit card tips and cash tips more automatic.
- Compare tips against employee hours. Make sure employees are earning minimum wage for your area. If their wage falls below that, you’ll have to cover the difference.
- Be careful about tip pooling. Define in advance how employees will share pooled tips to avoid conflicts. Remember that tips are not for management, and to always refer to your state laws.
- Never take away an employee’s tips. The government considers them employee property.
Simplify Tipping and Manage Your Team Right with Homebase
Tipping can be complicated, but only if you’re not equipped with the information and tools to make it work.
A clearer understanding of federal and state-specific tipping rules helps small business owners pay employees fairly while using tips to motivate great service.
However, while that knowledge is an asset, it still helps to have extra support and tools to keep you from making costly mistakes for your business. Spreadsheets and manual systems can only take you so far.
If you’re looking to simplify your small business operations and handle everything from time tracking to tipping to payroll, Homebase is right for you. With a free Homebase account, you can manage time tracking and scheduling for up to 20 hourly employees. And with features for payroll, and HR and compliance, our platform is an all-in-one solution designed to keep your costs low, your team operations simple, and your business moving forward.
Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.
