When managing a restaurant, processing payroll can be one of the more challenging tasks. Restaurant payroll presents a particularly tricky challenge because of the complex laws governing employees who earn income through tips.
Restaurant owners need to comply with all sorts of laws that protect tipped employees, which range from employment tax to reporting obligations of total tips earned. But don’t worry, we’re here to help.
In this primer, we address:
Who qualifies as a tipped employee
The rules and regulations around tipped employees
Tax issues to be aware of
Overtime for tipped employees
Restaurant benefits and deductions
How to do payroll for my restaurant
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Who qualifies as a tipped employee?
Sometimes even the hostess gets a tip — so who counts? A tipped employee is a worker who regularly receives more than $30 per month in tips, according to the United States Department of Labor.
What are the rules and regulations around tipped employees?
Under federal law — the Fair Labor Standards Act (FLSA) — all nonexempt (hourly) employees must be paid a minimum wage of at least $7.25 per hour. (Learn more about the minimum wage, which varies by state, county, and city.)
In some states, employers can take a tip credit against the minimum wage for “tipped employees.” Who qualifies as a “tipped employee” and the credit (if any) that can be taken varies by state. Some states follow the federal requirements — the Federal Insurance Contribution Act (FICA) Tip Credit — while other states impose additional requirements and/or limitations.
For “tipped employees,” however, an employer is permitted to credit up to $5.12 per hour in tips toward the minimum wage, provided that the employer pays the employee at least $2.13 per hour in cash wages (i.e., $7.25 minus $5.12), makes up the difference if the employee does not earn sufficient tips, and satisfies certain other requirements (including a notice requirement), which are discussed here.
Here’s an example: Your employee Joe works 30 hours in a week and makes $155 in tips that same week. You can take the maximum tip credit of $5.12 per hour worked for that week. That means you pay Joe $2.13 an hour and with his tips he makes more than the hourly minimum wage.
What tax issues should I be aware of?
Tips may qualify as taxable wages for your payroll. The Tax Equity and Fiscal Responsibility Act (TERFA) and Tip Reporting and Alternative Commitment (TRAC) laws govern taxable income. Under those laws, employees must earn more than $20 in a calendar month to have their tips taxed.
Automatic gratuities (such as adding an automatic tip to large-party bills) are considered revenue for the restaurant — not tips for the server — by the IRS. So, you may have to pay taxes on them.
To ensure employees earn minimum wage — and you’re filing/paying the right amount in taxes — your employees need to report the tips they earn. As an employer, it’s best to set up systems to track tips. Daily tip reports make restaurant payroll and your federal reporting the most accurate.
How do I figure out overtime for tipped employees?
Using the tip credit is common practice in the restaurant industry to save on labor costs, in states that allow it. But when you’re calculating overtime, you must calculate the overtime rate based on the full hourly wage — not the discounted tip credit. You can still use the discounted tip credit for all hours worked, but the overtime is calculated from the full rate.
Here’s an example of how to calculate overtime for a tipped employee from the Department of Labor’s Field Operations Handbook:
Let’s say an employer pays a cash wage of $2.13 per hour and claims tip credit of $5.12, and the tipped employee works 45 hours. The employer complies with the requirements to inform its employees about the tip credit, and the employee receives at least $5.12 per hour in tips.
Here’s how wages would be calculated:
- $2.13 (cash wage) + $5.12 (tip credit) = $7.25 (regular rate)
- 45 hours (total hours worked) × $7.25 (regular rate) = $326.25 (straight time wages due)
- 5 hours (overtime hours) × .5 × $7.25 (regular rate) = $18.13 (overtime wages due)
- $326.25 (straight time wages due) + $18.13 (overtime wages due) = $344.38 (total wages due)
- 45 hours (total hours worked) × $5.12 (tip credit) = $230.40 (total FLSA 3(m) tip credit)
- $344.38 (total wages due) – $230.40 (total FLSA 3(m) tip credit) = $113.98 (direct or cash wage due)
How do I treat benefits and deductions at my restaurant?
As an employer, it’s your responsibility to provide uniforms and materials. You cannot deduct the cost of these items from employees’ paychecks because it would result in them earning less than the minimum wage, according to the federal Fair Labor Standards Act (FLSA). That same law forbids deducting wages from employees because of negligent acts (all those broken dishes your new server drops) or because a customer did not pay.
If you provide your workers with meals while on the job, the IRS may consider this a “fringe benefit,” which means it is treated as taxable income to the employee. Free meals can also increase the employee’s overtime rate. (Make sure you check in with a tax professional to talk through what is considered a fringe benefit and what isn’t.)
So how do I do payroll at my restaurant?
You can process your payroll manually — a low-cost option, but time consuming and prone to errors.
Many restaurant owners seek outside help to run payroll. There are two ways to do this: You can hire an accountant or use a payroll software for your restaurant. Square Payroll ensures your business is compliant, imports your timecards with a click, and has fair and easy pricing.
If you’re new to the restaurant business, the best way to ensure you’re following the laws and getting all the tax credits and benefits possible is to seek some outside help. Make sure you talk with your lawyer if you have any questions.