TaxBandits Knowledge Base

What is the difference between service charges and tips in Form 8027?

When filing Form 8027, it is important to understand the distinction between tips and service charges, as they are treated differently for tax purposes.

Tips: A payment is considered a tip if it meets all of the following criteria:

• The customer voluntarily decides to leave the payment.
• The customer has complete control over the amount (including the option to leave no tip).
• The payment is not negotiated or set by the employer.
• The customer determines who receives the tip.

Since tips are voluntary, employees report them to the employer, and the amounts must be included in Form 8027 for tip reporting and allocation purposes.

Service Charges: Service charges are mandatory fees added to a bill, often for large parties, catering, or banquet services. These amounts do not meet the definition of a tip and are treated as wages for tax purposes. Employers must:

• Withhold federal income tax, Social Security tax, and Medicare tax on distributed service charges.
• Report service charges as wages on Form W-2, rather than as tips on Form 8027.

If your business includes service charges, following IRS instructions, you may need to report them on line 3 of Form 8027.