Ultimately, there are two mandates I would like to discuss, which are TEFRA and TRAC. For now, I will just focus on TEFRA. (I will explain TRAC in my blog in June!)
TEFRA (The Tax Equity and Fiscal Responsibility Act) was instituted to produce additional revenue through a combination of federal spending cuts, tax increases and reform measures. One of the areas targeted is reporting tips by employees of food and beverage establishments. According to the IRS, approximately 16% of total tip income is being reported by restaurant and bar employees. Obviously, that is a lot of money in taxes not being collected.
So, here are the requirements to be TEFRA compliant:
The target is for “large” restaurants where tipping is customary, so not cafeterias or fast food establishments. Furthermore, the IRS defines “large” as employing enough workers to accumulate 80 total hours worked in one day. For example, 10 total waiters or waitresses who work 8 hour days.
Once a restaurant determines that they are a large food or beverage establishment according to the TEFRA guidelines, they are then responsible for more reporting requirements. First, you must note and pay attention to who your directly tipped and indirectly tipped employees are. Directly tipped employees are tipped by the customer, typically being the wait staff. Indirectly tipped employees do not normally receive tips from customers, and are typically busboys, service bartenders, and cooks. Then, you must determine whether or not the total amount of tips reported amongst both directly tipped and indirectly tipped employees is less than 8% of the establishment’s gross receipts. If they are less, you must make a tip allocation to those employees who did not report enough tips to meet their share.
There are two methods for allocating tips. The first is the Good Faith Agreement, which is an agreement between the employer and employees specifying how the employee allocates tips when the 8% is not reported. This agreement must be in writing and attached to your Form 8027 when filing. (Form 8027 is the Employer’s Annual Information Return of Tip Income and Allocated Tips.)
The other methods are the Individual Gross Receipts, or Directly Tipped Hours Method. Allocations based on individual gross receipts are based off of all guest checks from services provided by the employee. Directly tipped hours are based off of the number of hours worked for the reporting period by each directly tipped employee. For this method, the establishment can’t have more than 25 full time employees. For either method, the data is plugged into an IRS formula.
TEFRA employers must also report the tip allocation amounts on their form W-2 in box 8. The employer is responsible for reporting the amount of the tip allocation, and is not responsible for withholding FICA, federal withholding, or paying payroll taxes on these tips. The employee must report that amount as taxable income when filing personal income tax returns, and are subject to FICA tax.