Paying Out Tips - Daily, Weekly, Payroll?

Do you remember your first day of work at your job? I remember being equally excited for the new adventure and anxious about how well I would do. I remember repeatedly saying everyone's name in my head so I could start getting to know my new team. I also remember looking at the calendar to find out when I would get paid!

At our company, we get an email each time we get paid that starts with, "It's one of the best days of the month...Payday!" This is a true statement that your company's employees probably echo. Every payday is great, but payday cannot come soon enough for certain industries and workers.

For service-based workers in a tipped job, providing clarity around how you get paid and what you are being paid is super important for setting proper expectations. Let's explore some common methods employers use to pay out their tipped employees and some best practice suggestions.

How Daily Tip Payouts Work

One standard method employers use in tipped industries is paying out all tips daily. This would mean that all tips are accounted for and paid out in cash to the appropriate employees at the end of the day or shift. 

The biggest advantage of this method is the immediate gratification an employee can receive by taking home their earnings each day. For lower-wage earners, this can be especially important as it allows them to use available cash to pay current bills.

In a situation where tips are paid daily, it is common for a worker to be paid a tipped wage below minimum wage, where they are expected to receive enough tips to bring their hourly rate to or above minimum wage. The hours worked multiplied by the tipped rate will be paid out on the paycheck according to the company's set payroll schedule, which is commonly done weekly or bi-weekly. This means employees are paid their tips daily and receive a paycheck regularly. 

Challenges with Daily Tip Payouts

There are two main issues with a daily tip payout approach. First, it requires having enough cash on hand to cover all tips. Second, paying out tips daily can create payroll tax issues for your employees. These issues can create an additional burden for the employer that may be heavy enough to make a daily payout undesirable. 

1. You Must Have Cash on Hand

For daily payouts, you must have a significant amount of cash on hand. With the rise of debit and credit card payments, most tips are paid electronically.

If you pay out these tips daily, you need cash on hand to cover these amounts, which creates negative cash flow as the funds from credit card payments won't be available until the transactions are settled.

This also necessitates daily cash runs and storing large sums on-site, which raises security concerns. 

2. Potential Payroll Tax Burden

The second, lesser-known issue that daily pay creates is a possible payroll tax burden for employees. 

Tips are considered taxable wages, meaning income tax must be withheld. Often, the income tax liability generated by tips exceeds the wages earned, leading to under-withholding and resulting in employees having to pay additional taxes when they file their returns. 

Here is an example of a paycheck that would illustrate this point:

In this example, our employee worked 23 hours at $2.13 per hour, earned $48.99 in wages, and received $1,325 in tips. Since the tips were already taken home, the employee would not receive them in their paycheck, but the tax liability on these earnings would exceed the wages. This could result in a $0 paycheck and under-withholding for taxes, leading to penalties during tax season.

Paying Tips with Payroll

Another option used by employers is to withhold tip payouts until the regular payday. In this scenario, employees do not take home any cash after their shifts and recieve all their earnings, including tips, with their paychecks.

As you can imagine, this option may not be favored by many workers who prefer frequent access to their earnings and can cause difficulties in competing for talent with other companies that may offer more frequent access to tips.

While this method may not be as popular, it does offer several advantages.

Benefits of Payroll-Based Tip Payments

No Cash Required

You eliminate the need to keep large sums of cash on hand, which improves security and cash flow.

Simplified Tax Compliance

This method avoids the tax issues associated with daily payouts, as taxes are withheld accurately from the full paycheck.

Clarity and Simplicity

Employees receive all their earnings in one paycheck, making it easier to track income and expenses.

Our Suggestion: Keep Your Options Open

A wise man once said, "When you only have bad options, you need more options."

We believe there is a hybrid approach that can satisfy your workers' desire for frequent access to cash while not adding an administrative burden on the organization. 

Hybrid Solution for Tip Payouts

Consider paying out cash tips daily and reporting them through payroll, while credit card tips are paid out with the weekly paycheck.

This approach allows employees more readily access to their funds while reducing payroll tax issues since a large chunk of tips will come from credit cards paid out weekly. 

This solution aims to remove barriers to hiring additional staff while not overloading the existing management staff with an additional administrative burden for payroll and cash distributions. If successfully followed, you will find that employees appreciate the immediate access to cash while also finding a weekly paycheck more enjoyable.

Find What Works for Your Business

We consistently try to develop the best solutions for our clients. This includes educating them about the common mistakes we see business owners make regarding their payroll and HR processes - things that can often have legal ramifications.

Make sure your business has the best processes in place to stay above board and successful.