Credit card tips and cash tips follow different paths through your books, but they end up in the same place for tax purposes. Both must be reported on employee W-2s and both require payroll tax calculations.

When a customer leaves a credit card tip, the full transaction amount (food, drinks, and tip) lands in your merchant deposit. The tip portion belongs to the employee, not the restaurant. Until you pay it out, that money sits on your books as a liability. You owe it to your staff.

Most restaurants handle CC tip payouts one of two ways. Some cash out servers at the end of each shift, pulling from the register to cover the tips they earned on card transactions. Others hold CC tips and pay them through the regular payroll cycle. Either method works, but you need to track the amounts carefully. Your POS system should generate a report showing exactly how much each employee earned in CC tips per shift.

Cash tips work differently because the money never passes through the business. The employee pockets the cash directly from the table. Your responsibility as the employer is to collect accurate tip reports. Employees should fill out a daily or per-shift tip log documenting how much cash they received. Federal law requires employees to report cash tips of $20 or more per month to their employer.

Here is where both types converge. Regardless of how the tip was received, reported tips must be included in payroll for tax withholding. Social Security, Medicare, federal income tax, and Wisconsin state income tax all apply to tip income. The employer pays their share of FICA on reported tips just like they do on regular wages. This is a cost that catches some restaurant owners off guard because you’re paying payroll taxes on money you never actually handled.

In your accounting software, CC tips should flow through a tips payable liability account. When tips come in through the merchant deposit, the liability increases. When you pay them out (whether through payroll or a daily cash-out), the liability decreases. At any given time, that account balance tells you how much you owe employees in unpaid CC tips. If it keeps growing or the balance doesn’t make sense, something is off in your tracking.

Cash tips don’t create a liability on your books since the employee already has the money. But they do need to appear in your payroll records. When you run payroll, reported cash tips get added to gross wages for tax calculation purposes, then subtracted back out because they’ve already been paid. The net effect is that taxes get withheld from the employee’s regular paycheck to cover the tax on their cash tips.

One thing to watch for is underreported cash tips. If your employees report less than 8% of your gross receipts in total tips, the IRS may require you to allocate the difference. This doesn’t change the tax the employee owes, but it does create reporting requirements for the business.

Good restaurant bookkeeping means reconciling your POS tip reports against your merchant deposits and payroll records regularly. Discrepancies between what the POS says was earned in tips and what actually flowed through payroll will create problems at year end. Catching them weekly or per pay period is much easier than untangling months of mismatched numbers.

If tip tracking feels like a mess or you’re not confident your payroll is handling tips correctly, that’s worth addressing sooner rather than later. Payroll tax errors compound quickly and penalties add up. Our Wisconsin small business bookkeeping services include working with restaurant owners to get these systems dialed in so the numbers are clean from the start.