Insights > Payroll > How employers handle tip reporting requirements the right way

How employers handle tip reporting requirements the right way

Published By:

Jon Davis

Updated: July 29, 2025

As a business owner, you probably don’t see every tip that your employees receive. A $5 bill here, a Zelle payment there, maybe a payout from a tip pool. These small payments might be a great bonus, but they’re not tax-free income, and they’re certainly not something you can afford to ignore.

Key takeaways

  • Both employers and employees must report tips and pay taxes on them
  • There are different reporting rules for service charges vs. tips
  • Employers may be able to use tip credits to decrease the amount of wages they pay
  • Failure to properly report tips could result in penalties, fees, or even legal repercussions for the employee or the business

The IRS has strict employer tip reporting requirements. Even if you don’t handle the money directly, you’re still responsible for keeping complete records. In many cases, you’ll also need to withhold taxes on this income to comply with federal and state laws.

 

In this employer’s guide, we’ll go over how taxes on tips work, forms you and your employees need to complete, and best practices for following tip reporting laws.

Why tip reporting compliance matters for employers

Some people assume that employees are 100 percent responsible for reporting their own tips, but that’s not the case. The IRS requires employers to track, report, and withhold taxes on tip income.

 

As an employer, prioritizing tip income reporting helps you stay compliant with tax laws. Tips count as taxable income, so you’ll need to include them in your payroll tax calculations.

 

Otherwise, you might significantly under-withhold taxes. For instance, a waitress may only earn a few hundred dollars a month in regular wages but thousands in tips. If you just report the wages, you (and your employee) won’t pay what they actually owe, which could draw unnecessary attention from Uncle Sam.

 

Failure to follow tip reporting laws can lead to accidental tax evasion, which can lead to some less-than-ideal outcomes. The IRS could audit your business, causing a major administrative headache. Both you and your employee may also face costly payroll tax penalties, as well as needing to pay interest for any unpaid taxes. The takeaway is that having a handle on this process makes good business sense.

 

Now that you understand why tip reporting matters, let’s talk about what exactly counts as a tip.

What counts as a tip (and what doesn’t)?

The IRS defines tips as “discretionary (optional or extra) payments determined by a customer that employees receive from customers.” The discretionary part is key. Customers must be free to choose whether they give a tip and how much to pay. That means auto-gratuities — such as a 20 percent service charge at a restaurant — don’t actually count as tips.

 

Here are a few common types of tips:

  • Cash tips, such as a $10 bill that a client gives to their hairdresser
  • Tips paid electronically with a credit, debit, or gift card
  • Non-cash tips, like tickets to a concert
  • Tips split among employees or paid out of a pool

 

Employees must report their tips to their employers if they add up to $20 or more in a single calendar month.

 

Does an employer have to report tips?

Yes, employers are required to report their workers’ tips to the IRS. It doesn’t matter what form these tips take — cash, gift cards, or something else. They must also pay and withhold taxes on this income.

 

Of course, before an employer can report anything, they need to get the right data from their employees. Here’s how.

2024_Q2_SMB_Simplify Growth_Banner_970x250_A

Employee reporting responsibilities: The role of IRS Form 4070

Employees can report their tips with Form 4070. This document gathers relevant tax information, including:

  • Employee’s name, address, and Social Security Number
  • Employer’s name and address
  • The period when they earned the tips
  • Amount of tips received

 

Tipped workers should complete Form 4070 for every month that they earn $20 or more in tips. They can also use another form — like an employer-created template — as long as it contains all the necessary information.

 

The deadline to submit a tip statement to the employer is the 10th day of the following month, or — if it’s a weekend or holiday — the closest following weekday. For example, a tour guide who earns $500 in tips in January should give Form 4070 to their employer by February 10th.

 

Employers must collect and retain employee tip reports every month. Let’s take a closer look at these obligations.

As always, you’re not liable for any unreported tip income that an employee fails to disclose to you. However, employees are liable and will still need to make tax payments on these earnings.

Employer responsibilities for reporting tips

As an employer, your duties go beyond just collecting tip paperwork. You also need to use this data to:

  • Calculate and withhold income tax, Medicare tax, and Social Security tax from the employee’s paycheck.
  • Pay your portion of Social Security and Medicare taxes based on the employee’s taxable wage and tips.
  • Report this taxable income on Form W-2 to make sure employees’ tax returns are accurate.
  • Submit the total taxes withheld on Form 941 every quarter.
  • Pay unemployment taxes and file Form 940.

 

On the employer’s side, this process will stay the same in 2025 with the passage of the One Big Beautiful Bill. It includes a provision called the “No Tax on Tips Act,” which allows tipped employees to deduct up to $25,000 in tip income from their federal income tax. This rule only applies to cash tips, which includes literal cash (like a handful of $5 bills given to a waiter or waitress) and electronic payments.

 

Employers must still report all tipped income to the IRS and withhold income tax as usual. And workers need to pay Medicare, Social Security, and (if applicable) state taxes on all tips, even if the total amount falls under the $25,000 limit. The only difference is that employees can deduct this income when they file their federal tax returns.

This bill applies retroactively, so employees can deduct any tipped income they earned starting on January 1, 2025. Currently, it’s scheduled to expire in 2029, so stay tuned for future changes to tipping rules. And for more insights on the recent legislation, see our resource on how the OBBB impacts employers and employees.

As always, you’re not liable for any unreported tip income that an employee fails to disclose to you. However, employees are liable and will still need to make tax payments on these earnings.

Tip pooling and tip sharing: What employers should know

The Fair Labor Standards Act (FLSA) allows employers to mandate that their staff “pools” or shares tips. These pools can take two forms:

  • Traditional tip pool: Employees who frequently receive tips — such as waiters and bartenders — combine these earnings and divide them among themselves.
  • Nontraditional tip pool: Tipped employees must share their wages with non-tipped employees like cooks or hosts. Businesses can only set up this type of pool if they don’t take a tip credit and pay all employees a cash wage of at least the federal minimum wage.

 

Managers and supervisors aren’t eligible to receive tips from either kind of pool. Employers also can’t keep any of the tips for themselves — this money is purely earned by employees, for employees.

 

Prompt processing is key, too. If you set up a tip pool, you must distribute the collected tips every payroll period.

Navigating federal and state wage requirements

The FLSA lets employers claim a tip credit, which means that they can count a portion of the employee’s tips toward meeting the minimum wage requirement.

 

Say, for instance, a bartender works 10 hours and earns $300 in tips. The federal minimum wage is $7.25 an hour, so the employer must ensure that the bartender earns at least $72.50 total (10 x $7.25). However, the employer can count up to $5.12 per hour of the employee’s tips as part of these wages, meaning they can pay as little as $2.13 an hour in direct wages.

 

Of course, tip laws and tax rules can vary by state. For example, California and Nevada don’t allow employers to claim tip credits, so they must pay the full minimum wage. As an employer, you must follow whichever law is stricter, so research your state’s requirements carefully to avoid financial penalties.

 

Service charges vs. tips: Why the IRS treats them differently

Some businesses have mandatory fees, such as bottle service charges. These payments aren’t voluntary for customers, so they don’t count as tips. That means they have different reporting and tax obligations.

“OnPay is pretty flawless. It puts me in control of data entry, lets me do multiple pay runs without any extra cost, and employees can access their own payroll records. I’ve had problematic experiences with other payroll companies making mistakes and leaving me to clean up the mess. But OnPay’s customer support is great — any issue or question that I have encountered is addressed almost instantly.”


— Chris Loverro, The Hazel Room

Best practices for staying compliant with tip reporting laws

Handling small business payroll taxes gets more complicated with tips, but it doesn’t have to be stressful. Set yourself up for success with these best practices:

  • Check out our guide to processing cash and credit card tips to decide how you want to collect payments
  • Educate employees about the importance of accurately reporting tips.
  • Update your tip records every month
  • Use the FICA tip credit to reduce your business’s tax obligation

 

You can also partner with a payroll provider to manage tip reporting and tax calculations easily.

2024_Q2_SMB_Simplify Growth_Banner_970x250_A

Streamline your tip reporting process

Keeping up with tip reporting requirements doesn’t have to drain your time or create compliance headaches. The key is establishing clear processes upfront: train your employees on monthly reporting deadlines, maintain organized records, and stay current with both federal and state requirements.

 

Payroll software like OnPay makes it easy to automatically track tipped income, handle the complex math behind FICA calculations, generate required forms, and ensure you never miss a deadline. This automation not only reduces errors but also frees you to focus on growing your business instead of juggling tax compliance. Ready to simplify your tip reporting? You can try all our tools free for 30 days — and our team is available to answer any questions!

Take a tour to see how easy payroll can be.

Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.

Recent articles: