Tip Reporting Made Simple — How Restaurants Can Stay Compliant and Pay Employees Correctly

Tips are a major part of restaurant payroll — but they also bring major compliance challenges. The IRS requires accurate reporting of ALL tips, and even small mistakes can lead to serious penalties.

Here’s how to stay compliant, protect your business, and ensure employees are paid correctly.

1. What Counts as a Tip?

A tip must meet these 4 requirements:

• The customer decides the amount

  
  

• It’s voluntary

  
  

• It’s not a service charge

  
  

• The customer can choose who receives it

  
  

Mandatory gratuity is NOT a tip — it’s a service charge and must be treated as wages.

This is one of the biggest mistakes restaurants make.

2. Understanding Tip Reporting Requirements

Employees must report all tips to the employer, and employers must:

• record tips accurately

  
  

• withhold appropriate taxes

  
  

• include tips in payroll

  
  

• comply with state and federal laws

  
  

A strong restaurant payroll system is essential.

3. What Is the Tip Credit?

Restaurants can pay a lower hourly wage if tips make up the difference — but only if all requirements are met:

• employees report all tips

  
  

• employees earn at least minimum wage

  
  

• employees are notified in writing (required!)

  
  

Improper tip credit use is a major source of lawsuits.

4. Allocated Tips

If employees report less than 8% of gross receipts as tips, the IRS requires the restaurant to allocate additional tips.

Without proper reporting systems, this becomes a nightmare.

5. Service Charges vs. Tips

Service charges (automatic gratuity) must be treated as wages, not tips. Examples:

• banquet fees

  
  

• large party automatic gratuity

  
  

• room service fees

  
  

They must run through payroll.

6. How to Stay 100% Compliant

✔ Use a POS that records tips accurately

Square, Toast, Clover, and Aloha all do this well.

✔ Train staff on proper tip reporting

Paper slips and written logs still matter.

✔ Track cash tips

These are the easiest for employees to underreport.

✔ Review payroll reports weekly

Catch errors before payday.

✔ Work with a restaurant CPA

Restaurant payroll is VERY different from other industries.

7. Common Violations That Lead to Penalties

• paying employees incorrectly when using tip credit

  
  

• not including service charges in payroll

  
  

• failing to track cash tips

  
  

• poor documentation

  
  

• incorrect FICA reporting

  
  

• outdated POS systems

  
  

• mixing kitchen tips with front-of-house (illegal in many states)