New Law on Tipped Income | What Employers Must Know Now

Just a little bit about EisnerAmper. Like I said, we're an audit, accounting and tax firm and we've got about 4,500 employees around the country. Our LA offices are in San Diego, Pasadena, Woodland Hills, San Francisco. So we have a big presence here in the California area and the restaurant practice is run out of our California Pasadena office. That's a picture of me. They make me put in these things, so that's okay. So let's start at the very beginning for everybody on this webinar. If you have employees that are making more than $30 a month in tips, those tips need to be reported. That seems pretty simple, but a lot of people have not engaged in putting their employee their tips through reporting their tips through the payroll process so that they can be taxed correctly. So if you're in that box where you haven't completely complied with the tip laws yet, you're going to need to do that.

Now, lots of times in the restaurant industry we say that when there's an event that happens, that's the best time to make change. So the event that has happened is this change in the tax law and that's what you have to approach your employees with if you are going to change the way that you process tips at this point, you want to use that event as the thing that is prompting the change, meaning it's not you changing the way you handle tips, it's the government insisting that you change the way you handle tips. So if you're still in that bucket where you're paying out tips at the end of the night in cash to your employees, that's not going to work going forward. And this law that changed just as a reminder as we're going through this this morning, this is in effect for this tax year.

So that means the information that you have to generate has to be ready to go out on the W year 25. This is happening right now. So I'm going to remind you, this is the event. The event is the tax change, the law and the tax law, the change in the tax law, and that's what's going to prompt you to have to go to your employee group and say, we have to change the way that we handle tips. They're all going to have to go through payroll now. We're not going to be able to pay out at the end of each day. So you need to think through that. So there's some myths there that you're aligned. We're talking about people have change the way that they're doing their tipping protocol

Income. That's kind of correct that the employee does have an obligation to declare income that they're getting, but the onus all lies on the employer to make sure that those tips are being taxed. Their IE them going through payroll. Okay? So the responsibility to record and tax the tips is on the employee, not on the employee. So it's not really the employee's responsibility. You have to participate in getting that reporting done. Employees only need to declare 8%. That 8% rule hasn't been true for a very, very long time. It used to be the very beginning of the way they wanted us to handle declaring tips. I think the point about this number two is you have to remember about what happened when the Patriot Act was put in place in 2001 after the nine 11 attacks. The IRS already has access to all credit cards. They already have all the information they need to audit you. They don't even have to call you. They can see what's being left on the credit card tips already without any information from you. So just remember that that's already out there. So they already know what percentage your employees are getting in tips. They can already calculate that without any data from you.

Employees are responsible for any taxes owed on tip income. So as you all probably know, payroll taxes are split between the employer and the employee. So when you put a payroll through and there are payroll taxes, half the payroll taxes are paid by you, half the payroll taxes are paid by the employee. That's the way that breaks down and you can usually see that on your payroll reports. So if tips are not going through payroll, what happens is that the tax that's owed on those tips by the employer is not being paid. That's where your liability is because the IRS can come back and say, these were the tips that went through your system. You did not pay your part of the payroll taxes on these tips. Therefore you owe the money. They rarely go after the individual employee, by the way. They always go after the employee because there's more money on the employer side.

So just as a matter of time and effort, it's easier for the IRS just to get your half of the payroll taxes than to go after hundreds and hundreds of employees trying to collect their part of the payroll taxes. So that's where your liability lies there. Tips must be paid out daily. No, that's not true. Tips can be paid through payroll in order for them to be taxed. And just to remind you of that, those credit card tips, that's actually your money. It's your money until you pay it out to the employees. So if you get into a regular cycle of paying them out when you run your payroll, that's acceptable. This is the part that's going to drive almost everybody on this webinar. Crazy, and I'm sorry for it. I don't make up the rules, but auto gratuities and service charges are not considered tips by the IRS. They're considered additional wages. That in itself creates a bunch of problems and we could do a whole webinar on that someday, and that's not today. But those auto gratuities and service charges are not going to be included in this tax deduction. So you can't include them in your payroll as tips because they're not allowed for this deduction.

So this is the big question mark that we have right now, and I can tell you I've talked to two or three payroll companies right now and they're all scrambling around trying to figure out what their pay stub is going to look like for these new tax laws. Okay, so we have two that we're dealing with. We have the no tax on tips, which we're dealing with today, and we have the no tax on overtime pay, which we're not dealing with today because we don't have enough information about how that's going to be executed. The very simple things that we know about the no tax on overtime is that when you do the overtime calculation, let's just say you have somebody making $17 an hour and they go into overtime, that overtime pay is going to be 1.5 times their regular rate of pay $17.

So that's going to make their overtime hourly rate $25. The difference between that $17 and the 25 50 is $8 and 50 cents. That's the tax that's not going to be owed the tax on the $8 and 50 cents. So we don't really know what that looks like yet until the payroll companies are able to set up a system where they're going to be able to differentiate between the tips on regular wages, I'm sorry, the tax on regular wages and the tax on that additional income for overtime. We don't have good regs on that yet, so we're still waiting for that. On the tip part, what's going to have to happen, and I have an example up there right now in this example, you can see that this employer does have a category for tips, a specific code, payroll code to put the tips in, and so it's showing up on the payroll stuff and that's great.

That's what you want is you want to separate tips out. So there's a line where you can see what the tips were. This says cash tips. That doesn't thrill me because it just should be all tips not differentiated between cash or credit card. It just should be all tips received. Then you can see that this is also breaking out overtime, double time. So it's going to look something like this. It's going to be regular time overtime, double time tips in all of the payroll companies are scrambling. They're all trying to figure out how the new presentation is going to look on the pay stub and also on the W2, and you are going to have to really be an advocate for yourself in pushing your payroll company to get you a sample of what it's going to look like and what it's going to look like for your employees because they're going to drag their heels on this like they do with everything else, and they're only going to address this with people that call them and say, we want to make sure we upgrade the payroll stub.

The upgrade of your payroll stubs not automatic with your payroll company. You are going to have to request it. So whether you're dealing with a DP or Paylocity or Paychex or Heartland, you have to start to advocate right now about what this payroll stub is going to look like and what the W2 is going to look like. More importantly when that gets issued to the employees, and you have to start pushing that. Now, I'm going to remind you a couple times during this webinar that this law is in effect right now. It's in effect for the 2025 tax year, which means at the end of the year, your payroll data is going to have to comply with this new law and your W2 is going to have to comply. This is all things that have to be done by your payroll company, so you need to start to advocate now to get what you need.

So unfortunately, this was used by both political parties as kind of a way to get people to vote for them in the last election, and I think most restaurant employees thought that this meant that they were actually going to be leaving at the end of the day with more money in their pocket, but that's not really how this has come out. So we're going to go through quickly what this looks like for the employee so that if you get questions from your employees, you can answer them and direct them in the right place. So it was signed into law just recently on July 4th, and again, it's for this current tax year. Okay? This is a temporary tax deduction, and this is an important word for you to remember. This is a tax deduction is not a tax credit. It's not a credit. It has to be used as a deduction.

It allows for certain tax deductions in 2025 through 2028, and then it expires unless it's re-upped at that point by the IRS. This is also only for federal taxes. It does not include any state or local taxes that might be affecting your payroll. So again, that's a conversation with your payroll company to make sure that it's set up only to take out the federal taxes involved. Eligible employees can deduct up to $25,000 of qualified tips, and we're going to get into that and they must file a tax return to benefit from this. If they're not filing a tax return, they get no benefit from this at all.

So we get into these eligible criteria, and this is in regards to tips that are eligible for this tax deduction. They have to be voluntary tips, which simply means it's what somebody writes in on a credit card slip, okay? It's not already put on the bill. It's not an auto gratuity, it's not a service charge. It's not something additional. It's something that the customer actually puts in to the credit card or leaves on the table as a tip for the employee, and it has to be properly reported, which means it has to be processed through payroll tips received in occupations that the IRS recognizes. They were supposed to put a list out 90 days after this law went into effect. We have not seen the list yet, but you can all assume on this webinar that the hospitality space is included in this. They're just also trying to see. We're waiting to see the final list to see who else might be included.

Tips are reported on the W2 or other IRS recognized forms for this webinar. The recognized form is the W2. It's the W2 that you're going to issue your employees after the end of the year for them to do their taxes, and that's the one you need to focus on. So here is how it breaks down, and this is where it starts to get a little bit in the weeds, but we'll work our way through it. So employees that are going to take advantage of this deduction have to make less than $150,000 a year. If they make more than $150,000 a year, there's some deduction in what they're allowed to actually include. Employees must have a verified social security number. You ask me what a verified social security number is. It means social security card in their name that can be verified. They must be a citizen of the United States, or they have to have a permit to work in the country if they're filing a joint return, which is not an option if they're married. If they're married, they have to file a joint return and their spouse has to have those same criteria that are mentioned up above. They have to have a verified social security number and they have to be a citizen of the United States or have a work permit that allows 'em to work here, and the cap on the deduction is $25,000.

A little bit of other stuff here to talk about. This only affects a very small portion of employees in the United States, less than 2%. There's about 4 million tipped workers in the United States, and this is going to affect very few of them. The vision excludes pretty much the lowest income workers, and we're going to show you some examples of that. And just as an idea, if you want to check your employees against the national standard, about 40% of all of the income that a tipped worker has comes from tips. So you might want to look and see if your team is fitting in there, meaning the hours that they get paid, plus the tips, and then do the tips represent about 40% of that total income. This is a very important point for everybody on this webinar. This provision does not affect the FICA tip credit that employers get at all.

Okay? The FICA tip credit is still there and it's still relevant. So the FICA tip credit is a credit that allows employers to reduce their taxable income by the amount that they paid in taxes on social security and Medicare that are associated with tips. If your CPA is not or has not in the past taken advantage of the FICA tip credit, you're going to want to talk to them about that because you want to make sure that you are getting your credit on tips that are declared through payroll on your part of the taxes, and it's a really valuable credit. It's about 80% of the taxes that you're paying. You can get back through the FICA tip credit. So you need to check with your CPA to make sure that you're taking advantage of that.

Okay? So let's just go through a couple of basics here. Qualified tips must be reported on the W2 that you issue. Qualified tips are still subject to social security and Medicare taxes. Qualified tips must be voluntary. No mandatory service charge, mandatory charges, auto gratuities, any of those. They're not qualified as tips. If the taxpayer is married, they must file a joint return and the deduction starts to phase out by a hundred dollars. For each thousand dollars by which the taxpayers modified total income exceeds 150. So once you go over 150 or 300,000 as a married filing jointly, it starts to get to be a smaller deduction.

So here's a couple of scenarios for you guys just to look at this. Scenario number one is actually from a live client of ours, okay? And so this pre OBBB by the way, that means the one big beautiful bill, and then under the next column is what it looks like under the new bill. So you can see this first example is the total income is 61,000, so they're qualified for this deduction. Remember that everybody gets the standard deduction when you file your tax returns. Everybody gets the standard deduction of 15,750. So you're going to have that first, and then you're going to have the $25,000 that you're allowed to take on this tip deduction. Up here, you can see that they had $26,000 in tips. The max is 25,000 for the deduction. So they've got a total deduction value here of 40,750. The standard deduction plus the qualified tip deduction, so they're going to owe 2000. The federal income tax is going to be, that they're going to owe is $2,192 versus in the old tax rules of they would owe $5,192 in taxes. So their savings there are $3,000.

Scenario number two is really more like a quick casual environment where they have a lower gross income and only $10,000 in tips. This is on the old tax law. They would owe $3,200 in taxes in this. They're going to owe 2000 and they're going to have a $1,200 savings there. And then you can see here, and by the way, we left the tips the same. We could recalculate this, but we did this example to show that their gross income is 176,000, so they're over the one 50, so they're going to get these two deductions, but their savings is going to be smaller as a ratio because they make more money. They would've owed $31,000 in taxes. They're only going to owe 25,900, so their savings is going to be about $5,000. So these are just a couple of examples of the way this is going to actually play out when they go to do the tax returns for the employees. Okay? That's what we've got for you, Jackie. You want to do some questions?

Jackie Gutierrez:Yeah. Thank you so much. Let's start at the top here. You mentioned that we can no longer tip out at the end of the shift. Can we still pay out cash at the end of the night? So long as we are recording all accurate earned tip income on payroll, this has been our practice for some time.

Jean Hagan:So the answer is yes, you can do that as long as you're taxing the tips that were received.

Jackie Gutierrez:Okay, let's see. Done. Does that include cash tips? Okay. That was a duplicate. We answered that. And

Jean Hagan:By the way, it includes both cash and credit card tips.

Jackie Gutierrez:Yes,

Jean Hagan:All tips.

Jackie Gutierrez:That's right. How do I know what the cash tip amounts are? Do I have to depend on the servers to tell me?

Jean Hagan:That's a very good question, and the answer is unfortunately yes. You do have to depend on the servers to tell you. You can audit it by knowing what their credit card percentage is on their credit card tips and see if they're declaring similar amounts as cash tips, because that's the way the IRS does it.

Jackie Gutierrez:Okay. Is the new law retroactive to January 1st for WT reporting? Yes.

Jean Hagan:Yep.

Jackie Gutierrez:See, that one's done. Why in scenario two is it only 10,000 deduction?

Jean Hagan:Okay, so let me go back. So scenario two is because they only made $10,000 in tips.

Jackie Gutierrez:Ah, okay. Why do you say it will only affect 4% of tipped employees?

Jean Hagan:So it's not 4% of tipped employees. It's that out of the entire workforce in the United States, only 4% of the workforce are tipped employees.

Jackie Gutierrez:Ah, understood. Will this affect the form 80 27 filing at year end?

Jean Hagan:Very good question, and no, it's not going to affect that at all. That's still required filing to put to report the amount of tips. There's no change in that at all. Okay.

Jackie Gutierrez:Okay. Thank you. For 2025 tax purposes, does this take effect as of July or Nope, we answered that one. Effective January one retro, I report all tips on payroll, but tips are paid out weekly by check. It's not paid through payroll. Is this Okay,

Jean Hagan:Well, that's interesting. I'm not sure I know what that means, but again, just remember that the important thing is any tips that are received have to have the appropriate payroll taxes applied to them.

Jackie Gutierrez:Yeah. Okay. Sounds like they're just separating the checks and so they've got their weight, their hourly hours worked, and then tips on a specific check. I fail to understand what is the benefit to the employer under the big beautiful bill?

Jean Hagan:Well, I don't know what you failed to understand. There is no benefit to the employer. I mean, it's not a bill that was directed towards helping the employer, or it's a bill that was directed towards helping employees.

Jackie Gutierrez:Yes. But it does. There's, and there's some responsibility on the employer side to report accordingly. Correct.

Jean Hagan:Every time they pass a piece of legislation, there becomes more administrative responsibility on the employer side.

Jackie Gutierrez:Unfortunately, yes. If we plan to transition all tip payouts to be processed through the regular payroll cycle, can this be made mandatory also, what are the best practices for rolling out the new policy to ensure a smooth implementation?

Jean Hagan:Great question. So first of all, if you have a TIP policy, I mean, almost every restaurant has TIP policy. They just don't memorialize it very well. So I'd give you two suggestions. I always suggest that if you have a tip policy like bussers get 10% bar gets 5%, however that looks, you should memorialize that in your employee manual so that it becomes part of the onboarding of employees that they understand there's a tip policy, and this is how it works. If you don't have a TIP policy in practice right now, the very best advice I can give you is to come up with a policy that you think should be in practice and talk to your employees and make sure your employees are engaged in the process of you setting up a TIP policy and then memorialize it in your employee manual.

Jackie Gutierrez:Thank you. And for all active CRA members, you do have the legal center program where you can get assistance in updating a portion of your employee to reflect what Jean was just suggesting you do. Okay. Next question. They're rolling in, so we'll keep going until as time allows. How do we back credit our employees for tips paid out January through August?

Jean Hagan:So I assume that means that you have not been putting the tips through payroll.

Jackie Gutierrez:Well, that's what it sounds like,

Jean Hagan:Right? I think my best advice to you is start doing it as soon as possible, and I wouldn't have any idea how you go back unless you have a record of the tips that were paid out, and you can apply the, you'll have to work with your payroll company and see how you can apply those payroll taxes to future checks to kind of get back square with the amount of taxes that we're owed.

Jackie Gutierrez:Great. Thank you. Should we be working with our payroll provider? Yes. To change the withholdings, or are the employees responsible for claiming the deduction?

Jean Hagan:Right. That's a great question. So what everyone anticipates happening is that in the future, the employees will start to request that you change their withholding because they know they're going to get this tax credit. So they're going to want to take advantage of getting more money in their check because they're going to take advantage of this credit when they file their tax return. So it's not your job to change their withholding. They will come to you if they want you to change their withholding, and you probably will see some requests for that, and it makes sense. I mean, there's no sense in them paying the money to the government if they're going to get it back in this tax deduction. So you could anticipate that you'll have employees asking to change their withholding.

Jackie Gutierrez:Great. Does the tips have to be stated separately for the 2025 W2?

Jean Hagan:Yes.

Jackie Gutierrez:Yep. Separate line item. Okay. For our married employees, just clarifying, we need to let them know that they will only qualify for the tipped credit if they file jointly. Also, a tipped worker qualifies for tipped credit.

Jean Hagan:So it's not required that the spouse be a tipped worker. It's just required.

Jackie Gutierrez:It must be jointly filed.

Jean Hagan:Yeah, it has to be jointly filed and that the spouse has a verified social security number and is a citizen of the United States or has a work permit allowing them to work here. They don't have to be a tipped worker, the spouse.

Jackie Gutierrez:Okay. Got it. If we have an Excel report that shows the cash tips that are distributed, can we report for them through payroll?

Jean Hagan:Absolutely.

Jackie Gutierrez:Okay. What about indirectly tipped employees? I guess that's tip sharing, tipping out?

Jean Hagan:Yeah. So it's the same for indirectly tipped employees. They should be recording their tips that they're receiving from other employees as well. If you have a tip pool or whatever, that kind of takes care of that problem. But tipped employees are required to record their income through tips, just like directly a tipped employee.

Jackie Gutierrez:Great final payment of wages, some cash tips for last shift that aren't recorded on a final paycheck due to the final check needing to be given to employees on the last shift. How do we record the cash tips for final shifts after the final check is already made?

Jean Hagan:Wow

Jackie Gutierrez:That's deep.

Jean Hagan:Yeah. I really do not know the answer to that question. I'm sorry to say, I'm not even sure I understand it. So an employee is getting terminated and you have to present them with a final check when you're terminating them, which you're required by law to have a check prepared. In general, if you can make that meeting to present them with their final check at a time when you can include the tips that they got on their last couple shifts, that's what I would suggest. But you do have to pay them out everything that they're owed on that final check. I'm not sure if I answered your question or not.

Jackie Gutierrez:I think you did. I was thinking the same thing, that it sounds like they're letting them finish a shift, which includes some cash tip sharing that could not be on that final check that they plan on giving them at the end of the night,

Jean Hagan:Is what it sounds like, can come back in the next day and get their final check. Yeah.

Jackie Gutierrez:Alright. We do not include gratuity into the employee's total tips on payroll. Correct. Is there any place in payroll that we would report it?

Jean Hagan:Yeah. So again, this is a complicated question. So auto gratuities service charges are not considered tips. They're considered other income. So they belong in the hourly wages that you're paying the employees not in a tip category.

Jackie Gutierrez:That's right. Alright. Forgive me if I'm doing some duplicates. I'm trying to get, they're coming in faster than we can get through them. Okay. That's okay. If we need to comply with those rules for the 2025 W2, is there a deadline to stop deducting taxes from the overtime and auto gratuity charges? Do we have to return the taxes that the employees were deducted from January to today?

Jean Hagan:No. So your job in this is reporting. It's not to be deducting. Taxes are doing any of those things. Your job is to be reporting, so there's no deducting going on at the time of payroll. This is all data that has to be collected so they can claim the deduction on their tax return.

Jackie Gutierrez:Great. Is the effective date for overtime also 1 1 25?

Jean Hagan:As far as we know until we see more regulations, yeah.

Jackie Gutierrez:Does this affect the 9 4 1 filing quarterly? I might have that document number wrong. I'm not an accountant. Does this affect the 9 4 1 filing?

Jean Hagan:Yeah, so the nine 40 ones that you're getting from your payroll company, they're probably going to have to rerun the quarterly nine 40 ones for 2025 once they have the new setup to report what needs to be reported, the new formatting. So there's nothing for you to do there at this point? We just have to wait and see what the format looks like for the payroll stub, the W2 and the 9 41 filings, and those are all sitting over on the payroll company sides waiting for us to see what that formatting looks like.

Jackie Gutierrez:Got it. Thank you for the advice though for the member because now they know what to look for proactively with their payroll company and what their payroll company should be doing for them. Alright. If a server has $100 in credit card tips, but only declares a hundred in credit card tips, even though some tablets paid in cash, what is the employer supposed to do about that? What does IRS expect? Do we force them to report at least 8% of their cash tips? What if they claim they got stiffed?

Jean Hagan:Okay, so let's start with the what if they claim they got stiffed? That's what every food server in the world tells you that they got stiffed. Most of the time that's not true. So a hundred dollars in credit card tips, but only declares a hundred dollars in credit card tips. Well, there's a record of what they received. It's the records right on the credit card. So that's what they have to declare. And you have every right as the employer to make sure that they declare at the minimum what's on their credit card tips, because that's what you're going to be held responsible for.

Jackie Gutierrez:So we collect the cash tips from the server and then add it into the employee's wages on their paycheck.

Jean Hagan:Well, it shouldn't be added into their, it should be a separate line item that says tips.

Jackie Gutierrez:Right. But I think that she's asking if it's okay to collect those tips and

Jean Hagan:Absolutely.

Jackie Gutierrez:And then turn it around on a paycheck.

Jean Hagan:Absolutely.

Jackie Gutierrez:Yep. Okay. How do we calculate this back to January 1st? Work with your payroll company.

Jean Hagan:Yeah. You're not going to do any calculation. Your payroll company is going to do that.

Jackie Gutierrez:Yep. I believe that these questions might be coming from maybe a controller that is in-house, and my advice would be to reach out to a payroll, the CPAs or payroll companies that can assist you with this.

Jean Hagan:Right.

Jackie Gutierrez:Okay. With this being retroactive, will the employees get a retro pay adjustment needing to be on a paycheck for the difference of what we already paid or adjust it on W2?

Jean Hagan:There's no change in what you're doing. Again, this is a reporting change.

Jackie Gutierrez:If all tips are currently reported and I have appropriate payroll taxes, what specifically should I be requesting from my payroll company regarding stubs and W twos?

Jean Hagan:Just that the tips have their own code on your payroll that clearly shows the amount of money received in tips. That's all you need to do.

Jackie Gutierrez:Asking what they are asking or want to know. If they give cash away, they are on the clear. But what you are saying is it doesn't matter how you give the tips away as long as you record it on payroll.

Jean Hagan:Not really sure about the question, but I'm going to say it again. Any tips that employees receive have to be taxed. If you're giving cash out, you've got to make sure then you record in payroll that they received cash and apply the payroll taxes to that amount so that you've taxed those tips.

Jackie Gutierrez:Great. This is actually a good question for people who are not familiar with this form. We are small. I am not familiar with Form 80 27 that someone asked about. I think this is important to address.

Jean Hagan:Yeah. So the Form 8 0 2 7 primarily affects full service restaurants and the reporting of their tips. So you should speak to your CPA and see if they feel that's something you should be filing or not. It's not necessarily for all operations, but you'd want to talk to your CPA to see what their opinion about filing that form is.

Jackie Gutierrez:Okay. Thank you. How do I account for tipped out staff IE Busers Kitchen? And then another question is, can I deduct the credit card amount to the server?

Jean Hagan:All right. That's a little confusing to me, but I'll repeat what I said earlier. Anyone that receives tips in the building has to record that tip, those tips as additional income, whether they're busers or bartenders or bar backs or whatever. If I'm a server and I'm tipping out a busboy, then I'm lowering the amount of tip that I need to declare, and the busboy is picking up the amount that I gave him, and he needs to declare that.

Jackie Gutierrez:Right. Okay, great. I feel like there's a lot of questions in here that have been answered already. So with that, I think we are going to say goodbye. Thank you. Thank you so much, Jean.

Jean Hagan:Absolutely. My pleasure. I hope everybody got some good information.

Jackie Gutierrez:Yeah, I know I did. So it'll help me better answer questions and use the slides as a resource to our members. Again, Jean, thank you so much for your time, everyone. Take care. Bye-bye.

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