Most coffee shops now take tips two ways: a prompt on the card reader and a jar by the register. Card tips usually end up in payroll because the processor keeps a record of them. The jar usually doesn't. The cash gets split at the end of the week and handed out, and nobody reports it.

That setup costs you twice. You pay 7.65% employer Social Security and Medicare tax on card tips without claiming the credit that gives it back. And the unreported cash leaves tax the IRS can still come after.

I spent nearly three years as a general accountant at a restaurant accounting firm with more than 150 restaurant clients. Tips are where payroll and the books meet, and that's where small errors grow.

Card tips count, and so does the jar

The IRS treats tips paid by cash, check, debit card, and credit card as cash tips. Any employee who gets $20 or more in tips in a month has to report them to you by the 10th of the next month. That covers card tips you paid out, tips handed to them directly, and their share of the jar. You then withhold income tax and the employee's Social Security and Medicare on those tips, and you pay the employer share.

Unreported tips are still your problem

Under §3121(q), you owe the employer share on unreported tips once the IRS sends a notice and demand. In United States v. Fior D'Italia (2002), the Supreme Court let the IRS estimate those tips for the whole business at once. It took the tip rate from card slips and applied it to total sales, without going employee by employee. Employees who don't report face their own penalty of 50% of the Social Security and Medicare tax on the unreported tips.

The credit you may be missing

Where tipping is customary for food or beverage service, and a coffee counter counts, you can claim a credit on Form 8846 equal to the employer Social Security and Medicare you paid on tips. The only tips excluded are the ones needed to bring an employee's pay up to $5.15 an hour. That's the 2007 federal minimum wage, frozen in the law for this credit. If you pay baristas $5.15 or more before tips, every reported tip dollar counts, and the credit is simply 7.65% of tips.

There are two catches. You can't also deduct the tax the credit covers, and the credit is nonrefundable, so a year with no income tax means carrying it forward. Under the Form 8846 instructions, you have 3 years from your return's due date to claim it, including on an amended return.

Your staff have more riding on it now

Starting with 2025, employees can deduct up to $25,000 of qualified tips a year through 2028, phasing out above $150,000 of modified AGI ($300,000 joint). Treasury's occupation list puts counter baristas under code 107. A tip qualifies only if it shows up on a W-2 or 1099, or the worker reports it on Form 4137. Starting with 2026 W-2s, you report cash tips in box 12 with code TP and the occupation code in box 14b. Jar money that never reaches payroll can't be deducted. The deduction doesn't touch Social Security or Medicare.

What it's worth

Example only, hypothetical numbers: You have six baristas at $16 an hour. Card tips run $1,500 a week and the jar about $400.

• Card tips come to $78,000 a year through payroll. Employer FICA is $5,967.
• Jar tips come to $20,800 a year, unreported. On notice and demand, that's $1,591 a year of employer FICA exposure, plus whatever your employees owe.

Every barista earns more than $5.15 an hour, so the full $5,967 is creditable. Claiming it costs you the $5,967 deduction. At an assumed 24% rate, you net about $4,535 a year. If you never claimed it, you can still amend the open years.

Report the jar too, and you pay another $1,591 in employer FICA and claim another $1,591 in credit. Each barista gets about $3,467 a year of tips on record that they can now deduct.

What to do

1. Check last year's return for Form 8846. If it's not there and card tips went through payroll, the credit is probably sitting unclaimed. Look back 3 years.
2. Compare your processor's year-to-date card tips to the tips on your payroll register. A gap there is exactly what an IRS estimate is built on, so fix it first.
3. Give staff a way to report the jar: a signed monthly statement or your POS's tip entry, due by the 10th. Record each person's share at the split.
4. Run the jar split through payroll in the period it's reported, so withholding and employer FICA follow it.
5. Confirm your payroll provider will fill in box 12 code TP and box 14b code 107 for counter baristas on 2026 W-2s. Check staff who only prep or brew separately, because they may fall under a different code.
6. Claim the credit going forward, and amend open years where the numbers justify the cost. A partnership or S corporation passes the credit through on Schedule K.
7. If you normally have more than 10 employees on a typical business day, check whether Form 8027 applies. Mostly takeout counters should look at the on-premises test.

The tradeoff

Reporting more tips means more employer FICA on every payroll deposit, and the credit doesn't come back until you file. Your baristas will also see more Social Security and Medicare withheld. In return you get a credit that roughly cancels the employer tax on tips, smaller exposure if the IRS ever asks, and W-2s your staff can use for the tip deduction.

If you want me to check your Form 8846 history, your card tips against payroll, and how you handle the jar, book a 30-minute Tax Leak Review.

Tristan D. Taylor, EA

​tristandtaylor.com​