Tipping
FIXE
Best Practices
Restaurant tipping best practices and accounting
Ryan
Short answer: record every tip on the paycheck, pay tips out through payroll, and keep the collection and payout on your balance sheet so they never distort your P&L. The part that gets restaurants audited isn’t tips at all. It’s service fees, which the IRS treats as restaurant income, not tips.
People ask me all the time, “how do I account for tips?” To get a handle on restaurant tipping, start by recording all tips on everyone’s paychecks. Employees used to ask me not to put tips on their paychecks because they didn’t want it to get taxed, but you should. I’ve seen too many restaurants get audited or penalized for not reporting tips. The IRS leaves it up to each employee to declare cash tips that they’ve earned to their employer. However, the restaurant typically receives the bulk of tips through credit and debit card sales and then reallocates those to their employees.
Paying tips on paychecks adds a cost to the restaurant. They have to pay employer taxes on those tips, but it’s still income going to employees.
From an accounting standpoint, it’s easier than counting cash at the restaurant each night to pay out tips. Instead, save those labor costs by simply paying extra payroll taxes.
Tips vs service fees, and why the difference matters
This is the table to screenshot. Nearly every tipping problem we get called into is somewhere in it.
| A tip | A service fee or auto gratuity | |
|---|---|---|
| Who decides the amount | The guest, freely | You do. The guest cannot skip it |
| Whose money is it | The employee’s. You are holding it for them | The restaurant’s, until you pay it out |
| Where it belongs | Balance sheet, as a liability | P&L, as revenue, with the payout as wage expense |
| Sales tax | Generally no | Generally yes, if the guest can’t decline it. Check your state |
| The common mistake | Running tips through the P&L, which inflates both sales and labor | Treating it as a tip and never charging sales tax on it |
Kitchen appreciation fees and health insurance reimbursement fees work the same way as service fees. Even though you pay those out to employees, the IRS considers them restaurant income. If the guest has no option to skip them, you need to be charging sales tax on them. A lot of restaurant operators forget to do that, and the IRS will make you pay those sales taxes if they audit you.
How do I allocate tips fairly?
Restaurant operators have two primary options when allocating tips.
- Percentage of hours worked. In a two-week pay period, let’s say the restaurant makes $1,000 in tips. If you worked 10% of the hours, you get 10% of the tips.
- Point system. Servers, bartenders, bussers, and expediters could each get a certain amount of the tips. You could include people in the back of the house as well.
I believe everybody should pool tips because everybody had a hand in generating that tip. The server should probably keep the biggest portion.
Before you implement any tip system, check your state law. This is the single most commonly botched compliance item in restaurant tipping. Some states reserve tips exclusively for front of house employees, some restrict who can participate in a pool, and the rules change. Get it confirmed for your state before you roll anything out, not after.
How should I calculate tips?
Finer dining establishments have intricate systems for reporting tips. At a certain point you need to get away from doing Excel calculations. As great as an Excel sheet can be, it will break at times. It shouldn’t be anyone’s responsibility to try to fix every crazy tip calculation. You should use a system to help manage it.
- TipHaus is a good solution.
- 7shifts is a scheduling platform that also has a built-in tip function.
- Toast payroll, although not one of our preferred restaurant payroll companies from a customer support standpoint, has a tip reporting function as well.
Where tips belong on your books
On any given day, a restaurant receives money from its customers. Tips should then be paid to employees, presumably with payroll. If every night I collect $100 and have weekly payroll, then I should pay employees $700 at the end of the week. That functionality should live on your balance sheet. You shouldn’t see the income from tips and paying tips on your P&L.
When tips run through the P&L instead, two things break at once: your sales look higher than they are, and your labor percentage looks worse than it is. Then you make a staffing decision off a number that was never real.
Frequently asked questions
Do I have to report cash tips?
Yes. The IRS leaves it to each employee to declare cash tips to their employer, and the employer reports them. Skipping it is how restaurants end up audited or penalized.
Is a service charge a tip?
No. If the guest cannot decline the charge, the IRS treats it as restaurant income, not a tip. You record it as revenue, and what you pay out to staff from it is wage expense.
Do I owe sales tax on a mandatory service fee?
Generally yes, if the guest has no option to skip it. Rules vary by state, so confirm yours. This is one of the most common findings in a restaurant audit.
Should tips go on the P&L or the balance sheet?
The balance sheet. You are collecting money on behalf of your employees and holding it until payday. It is a liability, not revenue. Service fees are the opposite and do belong on the P&L.
Who calculates tips if I work with FIXE?
Your POS or your tip tool decides who gets what. Your payroll processor moves the money. We make sure all of it lands correctly on your books, so tips sit as a liability, service fees sit as revenue, and your labor line reflects reality. Pricing is on our pricing page, starting at $690 a month per location.
