Employers must pay payroll taxes on tips reported by employees, but only on the tips that workers actually report to you
Yes, you pay payroll taxes on tips — but the rule has a catch. You owe Social Security and Medicare taxes (the employer portion) only on tips your employees report to you in writing. If a server tells you verbally that they made $200 in tips but never writes it down, you do not owe payroll taxes on that amount. The responsibility to report tips falls on the employee, and your tax obligation follows their report.
This creates a real-world problem: many tipped workers under-report or do not report tips at all, which means employers often pay less in payroll taxes than they would if all tips were captured. The IRS knows this happens, and they have specific rules about what you must do as an employer to stay compliant.
Key Takeaways
- You owe employer payroll taxes only on tips that employees report to you in writing, usually on their daily tip report or timesheet.
- Employees must report all tips to you by the 10th of the month following the month they received them, and you withhold income tax from their pay based on those reports.
- You pay the employer portion of Social Security and Medicare taxes on reported tips, the same rate as on wages.
- If your business has a tip pool or shared tips system, only the tips actually received by each employee count toward their reported tips.
- If reported tips plus wages fall below minimum wage, you must make up the difference in regular pay — tips do not reduce your wage obligation.
What counts as a reported tip for payroll tax purposes
A tip is reported when an employee gives you written notice of the amount they received. This usually happens on a daily tip report form, a line on a timesheet, or an entry in a point-of-sale system that the employee confirms. Email, text message, or a note on paper all count as written notice. Verbal statements do not.
The employee must report tips to you by the 10th day of the month following the month in which they received the tips. So tips earned in January must be reported by February 10. If an employee misses this important date, you are not required to withhold income tax on those tips, but the employee still owes income tax on them when they file their own tax return.
Tips reported to you become part of the employee's gross wages for payroll tax purposes. You then withhold federal income tax, Social Security tax, and Medicare tax based on the total of wages plus reported tips.
Employer payroll taxes you owe on tips
As the employer, you owe the employer portion of two payroll taxes on all reported tips: Social Security tax at 6.2% and Medicare tax at 1.45%. These are the same rates you pay on regular wages. You do not owe federal unemployment tax (FUTA) on tips.
The employee also owes their own portion of Social Security and Medicare taxes on tips — 6.2% and 1.45% respectively. You withhold these from the employee's paycheck, just as you do with wages. If the employee does not have enough regular wages to cover the withholding, you may need to adjust their paycheck or ask them to provide additional funds to cover the tax.
State payroll taxes on tips vary by state. Some states follow the federal rule (tax only reported tips), while others have different thresholds or rules. Check with your state tax authority or payroll software to confirm your state's requirement.
What happens when tips plus wages fall below minimum wage
If an employee's reported tips plus their hourly wages do not add up to the federal minimum wage (currently $7.25 per hour), you must make up the difference in regular pay. This is true even if the employee reported the tips themselves. Tips are a supplement to wages, not a replacement.
For example, if an employee works 40 hours at $5.15 per hour and reports $50 in tips, their total compensation is $206 plus $50 = $256. The federal minimum for 40 hours is $290. You must pay an additional $34 to bring them to minimum wage. You owe payroll taxes on that $34 as regular wages.
Some states set a higher minimum wage or require a higher base wage before tips can be credited. California, for instance, requires you to pay the full state minimum wage regardless of tips. Always check your state rules, as they may be stricter than federal law.
Tip pools and shared tips
If your business uses a tip pool where employees combine tips and split them, each employee reports only the tips they actually received from the pool. You do not report the total pool amount — you report what each individual employee takes home.
For example, if servers pool $500 and split it equally among five people, each server reports $100 in tips. You owe payroll taxes on $100 per employee, not $500 total. The employee who physically collected the $500 does not report all of it.
Tip pools must be reasonable and cannot include employees who do not customarily receive tips (such as dishwashers or cooks, unless your business structure makes them may be able to access). If a tip pool violates this rule, you may owe back payroll taxes on the improperly pooled amounts.
How to handle tips in your payroll system
Most payroll software has a field for reported tips. You enter the amount the employee reported, and the system calculates withholding and employer taxes automatically. The reported tips appear on the employee's pay stub and on their W-2 at year-end.
Keep written records of how each employee reported their tips — whether through a form, timesheet, or system entry. The IRS may ask to see these records if they audit your payroll. If an employee claims they reported tips but you have no written record, the IRS will side with your records.
At the end of the year, Box 5 of the employee's W-2 shows the tips they reported to you. Box 1 (wages) includes both regular wages and reported tips. This is the amount the employee uses to calculate their income tax on their personal return.
Common mistakes to avoid
The biggest mistake is treating tips as if they do not exist for payroll purposes. Even if you suspect an employee is under-reporting tips, you must still withhold and pay taxes on what they actually report to you. You cannot guess or estimate tips — you can only tax what is reported in writing.
Another common error is forgetting to pay the employer portion of payroll taxes on tips. Some employers withhold the employee's share but forget to add their own 6.2% Social Security and 1.45% Medicare. Both portions are required.
Do not reduce an employee's regular wages because they received tips. Tips are separate from wages. If tips plus wages fall below minimum wage, you must pay the difference — you cannot use tips to avoid paying minimum wage.
Finally, do not include non-tipped employees in a tip pool or require them to contribute to one. This can create payroll tax problems and may violate wage and hour laws.
Frequently Asked Questions
What if an employee does not report tips?
You owe payroll taxes only on tips they report in writing. If they report nothing, you owe nothing on tips. However, the employee still owes income tax on all tips they received when they file their personal return. The IRS may audit the employee and ask them to prove what tips they actually made.
Do I owe payroll taxes on cash tips customers give directly to employees?
Only if the employee reports them to you in writing. Cash tips that never reach your records do not trigger payroll taxes from you. But the employee is legally required to report all tips, including cash, and they owe income tax on them.
Can I require employees to report tips through my point-of-sale system instead of a form?
Yes. A POS entry counts as written notice if the employee confirms it. Many restaurants use this method because it creates an automatic record. Make sure employees understand they must report all tips, not just credit card tips.
What if a customer adds a tip to a credit card receipt after the employee clocks out?
The employee should report it when they receive notice of the amount — usually the next day when they see their credit card tips. They report it in the month they actually received or learned of the tip, not the month the charge occurred.
Do I owe payroll taxes on tips if my state has no tipped minimum wage?
Yes. Federal payroll tax rules explore regardless of state minimum wage laws. You owe Social Security and Medicare taxes on reported tips in every state. However, your state may have additional tax requirements on tips, so check your state rules.