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Case Study: Allocating Tips to Employees in Large Food and Beverage Establishments

Filed under Payroll Taxes. Fact checked on February 10, 2014.

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Large food and beverage establishments must follow tip allocation rules in the absence of a good faith tip allocation agreeement between the business and its employees. The case study, Sydney's Seafood, illustrates this type of tip allocation procedure.

If you are a large food and beverage establishment, and you do not have a good faith agreement in place for allocating tips to your employees, you will need to follow a specific process to figure out the allocations. 

The following case study takes you step-by-step through this process.

Sydney's Seafood is a large food and beverage establishment that has chosen to make tip allocations using its actual payroll period and gross receipts attributable to employees. 

The establishment had gross receipts of $200,000 for a payroll period and reported tips of $12,400. Directly tipped employees reported $11,400 of the total, and indirectly tipped employees reported the remaining $1,000.

Directly
Tipped
Employees
Gross
Receipts for
the Payroll
Period
Tips
Reported
A $36,000 $ 2,160
B 32,000 1,760
C 46,000 3,620
D 34,000 1,600
E 24,000 900
F 28,000 1,360
Total $200,000 $11,400

Step 1: The amount to be allocated to directly tipped employees is $16,000, which is computed as follows:

8% X $200,000 (gross receipts) = $16,000

Step 2: Tips reported by indirectly tipped employees are subtracted from this amount.

$16,000 (8% of gross receipts)
- 1,000 (Tips reported by indirectly tipped employees)
_____________
= $15,000 (Amount allocable to directly tipped employees)

Step 3: The amount to be allocated to each directly tipped employee is computed as follows:

Directly
Tipped
Employees
Amount
Allocable
To
Directly
Tipped
Employees
Times:
Gross Receipts Ratio
Equals:
Amount
Allocated
Per
Employee
A $ 15,000 18% ( = 36,000/200,000) $ 2,700
B $ 15,000 16% ( = 32,000/200,000) $ 2,400
C $ 15,000 23% ( = 46,000/200,000) $ 3,450
D $ 15,000 17% ( = 34,000/200,000) $ 2,550
E $ 15,000 12% ( = 24,000/200,000) $ 1,800
F $ 15,000 14% ( = 28,000/200,000) $ 2,100
Total 100% $ 15,000

Step 4: Each employee's shortfall is then calculated:

Directly
Tipped
Employees
Amount
Allocable
To
Directly
Tipped
Employees
Less:
Tips
Reported
Equals:
Employee
Shortfall
A $ 2,700 $ 2,160 $ 540
B $ 2,400 $ 1,760 $ 640
C $ 3,450 $ 3,620 . . .
D $ 2,550 $ 1,600 $ 950
E $ 1,800 $ 900 $ 900
F $ 2,100 $ 1,360 $ 740
Total shortfall $ 3,770

Step 5: The total amount to be allocated to directly tipped employees with shortfalls is $3,600, computed as follows:

$ 16,000 (8% of gross receipts)

- $ 12,400 (Total tips reported)

= $ 3,600 (Amount to be allocated)

Step 6: The $3,600 is allocated to each directly tipped employee with a shortfall, as follows:

Shortfall
Employees
Allocable
Amount
Times:
Shortfall
Ratio
Equals:
Amount of
Allocation
A $ 3,600 540/3,770 $ 516
B $ 3,600 $ 640/3,770 $ 611
D $ 3,600 $ 950/3,770 $ 907
E $ 3,600 900/3,770 $ 859
F $ 3,600 740/3,770 $ 707
$ 3,660

You have no liability to an employee if amounts allocated to the employee under these rules don't reflect your employee's actual tips.

If an employee's total tip allocation reported on Form W-2, Wage and Tax Statement, varies from the correct allocation by more than 5 percent, however, you must adjust the employee's allocation and review all tip allocations made to other employees in the same establishment to assure that their tip allocations are within 5 percent of the correct amount.

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