The restaurant industry is truly unique in that employees are more often than not bringing home most of their earnings as cash at the end of each workday. Of course, along with this comes a little bit of complexity when calculating payroll taxes on these wages.
When an employee’s net wages from their hourly salary are not enough to cover the withholdings on the taxes paid on their cash tips, this is known as a shortfall. And if not tracked properly, can lead to a big problem and leave you with more than a sinking feeling.
Typically, a restaurant will add all tips into the payroll for tax purposes, and then subtract them out because the employee has already these monies as cash. Shortfalls are even more common when there are deductions other than just the withholding taxes, such as contributions to a retirement solution or health insurance premiums. Here’s an example to illustrate how this can happen:
Let’s break down the taxes of a waiter that makes an hourly wage of $5.00 as a tipped employee, and worked a total of 20 hours one week. Then, they receive an additional $500.00 in cash tips that week.
Hourly Wage Gross: $5.00 x 20 hours = $100.00
Withholding: Social Security: $100.00 x .042 = $4.20
Medicare: $100.00 X .0145 – $1.45
Federal Income Tax: $100.00 X .1 = $10.00
Illinois Withholding: $100.00 X .05 = $5.00
Total Withholding: $20.65
Total Net Pay: $79.35
Cash Tips: $500.00
Withholding: Social Security: $500.00 x .042 = $21.00
Medicare: $500.00 X .0145 – $7.25
Federal Income Tax: $500.00 X .1 = $50.00
Illinois Withholding: $500.00 X .05 = $25.00
Total Withholding: $103.25
Total Net Pay on hourly wage ($79.35) – Total withholding on cash tips ($103.25) = Shortfall -$23.90
You can see that their total withholding on the cash tips that they brought home for the week are greater than their net pay on the salary. The employee is short $23.90 that week to cover the withholding taxes on their tips. If this is being monitored properly, the employer could have the shortfall roll over to the next pay period to make up the difference in taxes. However, if it is not being tracked, the employer ends up paying the difference and are not even aware of it!
This is why it is so important to track shortfalls as a restaurant employer. $23.00 may not seem like a big deal, but if each employee at the restaurant were to have this happen several times per year, it would really add up.