For many people, leaving a tip on a table might mark the end of their meal, but this marks the beginning of what can be a much longer and ever-changing series of transactions.
Tips present daunting accounting problems to employers. Employers must include tips in the total wage figure, on which they pay social security and state taxes.
Traditionally there had been an opinion that declaring eight percent of sales as tips was enough to keep the IRS happy. With the looming budget gap and the knowledge that 18-20 percent of sales are being left on the table, the IRS has stepped up efforts to reclaim its full and rightful share.
Yet, with the right tools, owners of tip-based establishments can comply with the new IRS rules and even benefit from them.
In 2004 I began to develop software to deal with the new IRS requirements. Grata-Soft Solutions, an acronym for “Gratuity Reporting and Tip Administration,” has matured into a variety of efficient tools capable of automating any of the three IRS tip programs (GrataSoft.com). Our software reduced administration to about 100 hours per year, exponentially less than IRS estimates of 4,800 hours.
In the process I amassed much experience with the IRS, their tip program requirements, plan features, as well as my own implementation problems. It occurred to me that I had compiled a wealth of information on the subject that could greatly benefit my colleagues. Many are afraid (as I had been) to solicit the IRS for such information because of the possibility of becoming a “blip” on their radar screen.
I constructed www.TipCompliance.com as a public forum website for employers and managers of tip-based establishments to familiarize themselves with plan details, options, and techniques for implementation.
Restaurant employers — and patrons who have always wondered how the “behind the scenes” accounting is done — can get their questions answered. Here is an insider’s look at what happens to servers’ tips.
What counts as a tip? The words tip and gratuity are often used interchangeably, but the IRS defines a gratuity as an amount predetermined by the establishment, and not one left to the discretion of the customer. For groups of six or more, the restaurant might add 20 percent to the total check. That is a gratuity.
Tips are regularly based on a percent of the bill less taxes. Tip amounts can vary, but customarily are 15 to 20 percent or more (www.Tipping.org).
Some businesses “pool” tips, which are then divided with support employees such as bussers and service bartenders.
Other restaurants may require that servers “tip-out” members of the support staff at the end of their shift, meaning that servers pay a percentage of their sales (not tips) to the other staff. Thus, a small tip may result in the server receiving less, but their support staff might not suffer.
In general, 20 percent or more of a server’s tip may be conveyed to others, and their base hourly wage is typically well below minimum wage.
The IRS expects directly tipped employees to declare 100 percent of the tips that they retain. Technically, gratuities are not to be included in this amount and should be paid as wages to the employees on their paychecks.
Gratuities must be kept separate from tips. This gives the IRS several clear advantages.
With gratuities normally set at 18 to 20 percent, to combine these with under-declared tips would mask a shortfall in the employee’s favor.
Showing the additional wages from gratuities on a paycheck helps to fund mandatory taxes and voluntary deductions such as health premiums and 401(k) payments. By boosting wages, they help meet minimum wage requirements. But for the restaurant owner, including gratuities in with the wages will reduce the tip amount calculated for the Social Security Tip Credit.
The Social Security Tip Credit is a credit made available to owners of tip-based establishments. The amount of the credit is equal to the amount of Social Security paid on those tips declared by staff in excess of minimum wage.
More specifically, each employee’s tip declarations, wages, and hours are tallied by month. For each employee, when their monthly tips plus wages divided by hours worked exceed the minimum wage, the tip amount making up the excess portion is totaled. The tip credit is equal to the amount of Social Security match (7.65 percent) paid by the employer on this calculated total.
Let me reiterate that this is a credit and not a deduction. This means that the benefactors (the employers) receive a dollar for dollar credit against their tax obligations, when allowed. As with many other deductions and credits, in recent years the Alternative Minimum Tax (AMT) has limited or eliminated the use of such vehicles.
Changed tax credit rules. The tax credit rules changed when, last May, Congress passed the Small Business and Work Opportunity Tax Act of 2007, approving an increase in the federal minimum wage, and subsequent future increases. Although minimum wage is the driver for excess tip calculations, its present level of $5.15 per hour will remain fixed through future increases for purposes of calculating the Tip Credit. (Also in this legislation was the removal of the Social Security Tip Credit from falling under AMT rules. Tip Credits may now be applied toward AMT obligations).
Because New Jersey’s minimum wage is so far ahead of the federal level, here, the impact of the federal increase was negligible. But the new law multiplied the accounting complexities. By not electing the tax credit, an additional $10,000 in declared tips could end up costing the establishment $530. Electing the tax credit could result in a net benefit of $500.
Prior to these changes, the IRS had offered several tip programs. By using pay period feedback and training, the IRS encouraged employers to increase tip declarations to 100 percent. If compliant, the employer stood to gain audit immunity (although not the staff). These programs came at the costs of complexity and a mountain of administration estimated by the IRS at 4,800 hours annually.
Attributed Tip Income Program. This year the IRS launched a new tip program called ATIP, or Attributed Tip Income Program. Simply put, this program sets a minimum tip declaration level for the establishment at two percent less than its previous year tip rate. If charged tips for 2006 were 18 percent, the cost of ATIP participation would be to attribute 16 percent of employee sales as if they had declared this amount in tips.
This very well could be the IRS’s new threshold of pain, at which it perceives no value in an audit. In fact, compliant operators are afforded audit immunity for both themselves and their employees. As one might expect, administration remains complex.
In 2004 the IRS asked me if I would be interested in “voluntarily” participating in its TRAC (Tip Reporting Alternative Commitment) program. Even at that time I was aware of a great deal of uncertainty in the marketplace surrounding tip program adoption and the value in terms of audit protection. I learned that many of the failures in protection were typically caused by operators being unable to properly administer program requirements, and that these requirements were hefty and cumbersome.
It became clear there was great potential for a software product that could lower this burden while increasing plan compliance. GrataSoft Solutions (GrataSoft.com) can now automate of the three IRS tip programs. ATIP relies even more heavily on automation and direct interaction with our point of sale system. The cost of obtaining 100 percent tip audit immunity for both house and staff as compared to the previous year under TRAC is estimated to be an increase in tips declared of just over $2,000, which will result in a tip credit of just about $150 — nearly equal and opposite to its cost.
The time saved with GrataSoft was astounding. The IRS estimated that administration would require 4,800 hours, and with the software just 100 hours are needed. Domestic and international patent applications were filed in 2006.
TipCompliance.com went live last August. Restaurateurs can now post questions and reply to one another on their own tip experiences, as well as maintaining links to forms, articles, instructions, tools and industry professionals.
In summary, being tip compliant has never been easier, more beneficial, and potentially lucrative for owners and tip-based establishments through the use of the right tools and making the right tip plan selection and tax decisions.
John Marshall is the owner of Main Street Gourmet Eatery and Bakery in Kingston, Main Street Fine Catering, and Main Street Euro-American Bistro and Bar in the Princeton Shopping Center. He is president of GrataSoft Solutions, developer and publisher of Grata Restaurateur; a patent pending software solution for tracking and managing tip policy. He is also the publisher and editor of TipCompliance.com, an online forum.