'Large Restaurants' and the 8% Rule
Large restaurants must follow special tip reporting rules. The IRS defines "large restaurants" as those where tipping is customary, food or beverage is provided and consumed on the premises, and, in the preceding year, the average number of hours worked by all employees on a typical business day was more than 80. If your restaurant meets these criteria, you must allocate tips to your employees if the total tips reported are less than 8 percent of total sales (adjusted for carry-out sales, service charges and sales taxes).
Allocated tips are subject to the employer's portion of FICA taxes. Tips can be allocated based on each employee's share of gross receipts, hours worked, or another method based on an agreement with your employees. Most restaurants allocate using the gross receipts method. You only withhold income and FICA taxes on reported tips, not on allocated tips. Allocated tips are reported separately on the employee's W-2.
Although the 8 percent figure is the threshold used by the IRS for tip allocations, your employees are still required to report all their tip income. Even if your employees report 8-percent in aggregate, your restaurant may still be audited and assessed back FICA taxes on unreported tips as calculated by the IRS, particularly if, as mentioned, unreported tips are less than charged tips.