How do I track tips and gratuities in my books?
The most important thing to understand is that tips are not your revenue. They belong to your employees. When a customer leaves a tip on a credit card, that money flows into your bank account temporarily, but it was never yours. Your books need to reflect that distinction clearly.
Set up a liability account in your chart of accounts called something like “Tips Payable.” When credit card settlements hit your bank and include tip amounts, the tip portion gets recorded as a credit to Tips Payable. When you pay those tips out to employees, either nightly or through payroll, you debit Tips Payable to clear the balance. Done correctly, that account should stay close to zero over time. If the balance keeps growing or goes negative, something is off in how tips are being recorded or paid out.
Credit card tips are the easier side of this because there is a paper trail. Your POS system tracks them, your credit card processor includes them in settlements, and they show up on your bank statement. The challenge is making sure they get separated from sales revenue when you record the deposit. Lumping everything together as income overstates your revenue and creates a mess at tax time.
Cash tips are trickier. Employees who receive more than $20 in cash tips per month are required to report those to you. You then include the reported amounts in their gross wages for payroll tax withholding. Many business owners skip this step, but the IRS expects it. If you run a restaurant or bar with more than 10 employees, you may also need to file Form 8027 annually to report total tip income.
All tips, whether credit card or reported cash, must run through payroll. You withhold income tax, Social Security, and Medicare from the employee’s reported tip amount. You also pay your share of FICA on those wages. There is a silver lining here. The Section 45B FICA tip credit lets employers offset some of that cost on their tax return, but only if you are properly reporting tip income through payroll in the first place.
Keeping tips clean in your books comes down to consistency. Record credit card tips through the liability account every time deposits are entered. Make sure your POS reports reconcile to what actually hit the bank. Run reported cash tips through payroll every pay period. Reconcile Tips Payable regularly to catch discrepancies before they snowball.
If your books are behind or tips have been mixed in with revenue for months, working with a small business accounting firm to get things straightened out is worth the investment. The longer tip tracking stays messy, the harder it is to untangle and the more likely you are to have payroll tax issues down the road.
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