Tip Reporting for Restaurants and Salons

Tips move through your point-of-sale system, your payroll and your employees’ tax returns. This guide summarizes the IRS’s page on tip recordkeeping and reporting, read on 2026-10-16. Rules and forms change, so confirm with the IRS and a qualified tax professional. This is general information, not tax or legal advice.

What counts as a tip

The IRS defines tips as discretionary payments that customers voluntarily give to workers for services performed. It lists cash tips received directly from customers, non-cash tips such as event tickets or other items of value, and tip amounts received from other workers through tip pools or tip sharing. It says “cash tips” include tips paid in a cash medium, including checks, credit cards, debit cards, gift cards and other electronic or mobile payments denominated in cash.

Service charges are not tips

The IRS says service charges are extra amounts charged to a bill, such as mandatory service charges, and are not tips. It gives these examples of service charges: automatic charges added to a bill (for example a mandatory 18% charge for large parties), required gratuities included in a contract or invoice, and digital payment prompts that require a customer to select a tip greater than zero before paying. A payment is a tip only if the customer voluntarily decides to pay it and determines the amount. If a customer adds an extra amount on top of an automatic service charge, only that additional voluntary amount is a tip.

For employers, the IRS says service charges distributed to employees are treated as wages and must be included on the employee’s Form W-2, and that service charges are income to the employer whether or not distributed. It also says that in an examination the IRS may ask the employer to show how sales subject to service charges are distinguished from sales subject to tipping, using point-of-sale records. Suggested tip calculations printed on a customer’s bill are addressed separately on the IRS page; read it if your receipts show them.

What employees must do

The IRS says employees must:

1. Keep a daily tip record, including the date and value of any non-cash tips. The IRS points to Publication 531 for the steps.
2. Report cash tips to the employer in a written statement, unless the total is less than $20 for the calendar month with respect to that employer. No particular form is required; the statement must include the employee’s signature, name, address and Social Security number, the employer’s name and address, the period covered and the total cash tips received.
3. Report all tips on their federal income tax return. Tips not reported to the employer are reported on Form 4137, which also computes the Social Security and Medicare tax owed on them.

Self-employed workers, such as some hair stylists, rideshare drivers and gig workers, are not subject to the employee reporting rules, but the IRS says their tips are generally part of gross receipts reported as business income on Schedule C and are subject to self-employment tax.

What employers must do

The IRS says employers must retain employee tip reports, withhold income tax and the employee’s share of Social Security and Medicare tax on wages and tip income, deposit those taxes, and pay the employer’s share of Social Security and Medicare on wages and reported tips. Reported tips go in Boxes 1, 5 and 7 of the employee’s Form W-2, and the total of cash tips reported to the employer is separately reported in Box 12 with code TP, along with the applicable Treasury Tipped Occupation Code in Box 14b. Taxes are reported on Form 941, and most employers also file Form 940 for federal unemployment tax.

The IRS also says a 0.9% Additional Medicare Tax applies to Medicare wages above $200,000 in a calendar year, that employers must withhold it, and that there is no employer share. At large food or beverage establishments where total reported tips are less than 8 percent of gross receipts (or a lower rate the IRS approved), the employer must allocate the difference among tipped employees; allocated tips appear in Box 8 of Form W-2.

Qualified tips deduction, 2025 to 2028

The IRS says the Working Families Tax Cuts Act added a deduction for qualified tips, available for tax years 2025 through 2028. Qualified tips are voluntary cash tips received in an occupation that customarily and regularly received tips on or before December 31, 2024. The IRS lists the limits: a maximum of $25,000 per return, phase-out for modified adjusted gross income over $150,000 ($300,000 for joint filers), a valid Social Security number, joint filing for married taxpayers, and special rules for specified service trades or businesses. It also describes new information-return requirements for employers and other payors, with transition relief for tax year 2025. Because these details are changing, read the IRS page and its linked notices before applying them to your payroll.

Where this fits

If you run payroll, our paycheck calculator estimates federal withholding and FICA on a paycheck, and our payroll software ranking lists providers. For card tips and processing, see credit card processing fees explained, and the industry pages for restaurants and salons.

What we did not verify

We did not read IRS Publication 531, the Treasury Tipped Occupation Code list, the linked notices, or any state tip, tip-credit or service-charge rules. We did not verify how any POS system or payroll provider reports tips. Check with a tax professional before changing how you handle tips.