Tip jar tax law in Washington State

A client who manages a restaurant in Washington State was wondering how tip jars were handled by the law. My boss asked me to do some research to answer the client’s questions. This post is to share with the world what I found out. I will just quote from my e-mail correspondence:

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This seems not to be a legal issue in the state of Washington. “(11) Gratuities. Tips or gratuities representing donations or gifts by customers under circumstances which are clearly voluntary are not part of the selling price and not subject to tax. However, mandatory additions to the price by the seller, whether labeled service charges, tips, gratuities or otherwise must be included in the selling price and are subject to both the retailing B&O and retail sales taxes.” (http://apps.leg.wa.gov/wac/default.aspx?cite=458-20-124)

However, this is a federal issue. “All cash tips received by an employee are wages for FICA tax purposes and, therefore, must be reported to the employer unless the cash tips received by the employee during a single calendar month while working for the employer total less than $20.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

To be classified as a tip, the four following points must “generally” be met: “(1) the payment must be made free from compulsion; (2) the customer must have the unrestricted right to determine the amount; (3) the payment should not be the subject of negotiation or dictated by employer policy; and (4) generally, the customer has the right to determine who receives the payment.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

Points of law:
– “The employee must give the employer a written statement (or statements) of cash tips by the 10th day of the month after the month in which the tips are received.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

– “If an employee fails to report tips to his or her employer, the employer is not liable for the employer share of FICA taxes on the unreported tips until notice and demand for the taxes is made to the employer by the Service. The employer is not liable to withhold and pay the employee share of FICA taxes on the unreported tips.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

– “The employer withholds the employee share of FICA taxes on the reported tips from the wages of the employee (other than tips) or from other funds made available by the employee for this purpose…The employer pays both employer and employee shares of FICA taxes in the same manner as the taxes on the employee’s non-tip wages and includes the reported tips on the employee’s Form W-2, Wage and Tax Statement.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

– “An employee who fails to report tips required to be reported to an employer is subject to a penalty equal to 50 percent of the employee share of FICA taxes on those tips, unless the employee can provide a satisfactory explanation showing that the failure was due to reasonable cause and not due to willful neglect.” (http://www.irs.gov/pub/irs-drop/rr-12-18.pdf)

Further Reading:
http://www.irs.gov/taxtopics/tc761.html
http://www.hollandcpa.cc/Articles/Deposited/default.asp

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That first e-mail did not completely clear up the client’s questions. Here is the second e-mail I sent out:
Unfortunately, there is not specific black letter law on tip jars. However, there are at least five separate web sources that stem from an applicable IRS judgment on this issue. Here are my findings based on tip related black letter law and the tip jar web sources:

  • The IRS has ruled in a past case that tip jars are considered to be tips. This is true even though the customer may not be specifically designating who is receiving the payment in a tip jar. However, if the employer (management) takes control of the tip jar for purposes other than safe keeping the tips will be considered compensation (wages) and subject to employment taxes.
  • The employees and not the management are to agree upon tip disbursement. It is the employees’ and not the managements’ money, if it is desired to keep the status of a tip.
  • From the IRS case that serves as precedent, the employees disbursed the tips among themselves weekly based on hours worked in that week. Managers were not given any tip monies. Managers did keep the money in the company safe.
  • If the tip requirements are broken, the monies will be considered compensation (wages).

Regarding specific questions:
Can I at my discretion give more to some and less to others? For example an employee of the month receives a larger amount?

No. This is to be decided upon by the employees in order to keep the status of a tip.

Are all of the above tips to be taxed regardless of how they are used? For example can we use some of the money for company party and others for monetary tips?

No. In order to keep the status of a tip they must be disbursed to the employees by the employees.

If the actual tip amount is less than $20 for an employee that month, then I don’t have to do any with holdings. Right?

Correct. Also, it is the burden of the employee to report tips to the employer.

Tip Jar Specific References:
http://www.hhcpa.com/blogs/income-tax-accountants-cpa/the-tip-jar
https://www.visionpayroll.com/kb/2009/07/irs-rules-distributions-from-tip-jars-are-tips-not-wages/
http://www.medowscpa.com/cpa-10002-advice-on-employer-withholding.aspx
http://www.hollandcpa.cc/Articles/Deposited/default.asp

I hope this helps. Let me know if there are further questions. Thanks!