How do I handle a cash advance on an employees payroll?

All cash and non-cash tips an employee receives 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, unless the tips received by the employee during a single calendar month while working for the employer total less than $20. Cash tips include tips received from customers, charged tips (e.g., 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.

Employee Responsibilities

Employees who receive tips must do three things:

  1. Keep a daily tip record.
  2. Report tips to the employer, unless less than $20.
  3. Report all tips on an individual income tax return.

When Employees Should Report Tips to The Employer

Employees must report tips to the employer by the 10th of the month after the month the tips are received. For example, tips received by an employee in August 2014 are required to be reported by the employee to the employer on or before September 10, 2014. If the 10th falls on a Saturday, Sunday, or legal holiday, an employee may give the report to the employer by the next day that is not a Saturday, Sunday, or legal holiday. An employer may require employees to report tips more than once a month. However, the statement cannot cover a period of more than 1 calendar month.

An employer’s or employee’s characterization of a payment as a “tip” is not the last word. Distributed service charges (often referred to as “auto-gratuities” by service industries) should be recorded as non-tip wages. Revenue Ruling 2012-18 lists the factors to determine whether such payments are tips or service charges.

Employer Responsibilities

The employer has several responsibilities regarding tips including recordkeeping, reporting, collecting taxes on tips, filling and filing forms as well as depositing taxes.

Employers must -retain employee created tip reports, withhold federal income tax and the employee share of FICA and Medicare taxes based on wages paid and tips reported to the employer.  The employer reports this information and deposits taxes along with all other employment tax obligations the employer has. Employers must calculate and pay the employer portion of FICA and Medicare taxes as well.  This is calculated on the total wages paid and the tips reported to the employer by tipped employees.

Tips reported to the employer by the employee are to 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. Enter the amount of any uncollected social security tax and Medicare tax in Box 12 of Form W-2. For more information, see the General Instructions for Forms W-2 and W-3.

Employers report FIT, FICA and  Medicare taxes withheld from employees’ wages and the employer calculated portion of FICA and Medicare taxes on Form 941, Employer’s Quarterly Federal Tax Return.  The taxes are deposited according to current federal tax deposit requirement for the employer.

Employers are also required to file  Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, and depositing the calculated taxes as well.  The employee pays no FUTA tax, it is levied only on the employer.  More in a later chapter on FIT, FICA, Medicare and FUTA taxes.

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