Tax Talk & Business Tips

Tip pooling can feel like one of those “I’ll figure it out later” topics—until you’re faced with an IRS audit or a frustrated employee. The rules aren’t just for big restaurants; they apply to any business where tips are part of the paycheck.

From cafés to salons, the Department of Labor and IRS have specific guidelines on who can share in tips, what counts as a tip versus a service charge, and when managers can (and can’t) participate. Knowing the difference isn’t just about compliance—it’s about protecting your business and your team.

1. What Counts as a Tip?

A “true tip” is simple: it’s a voluntary payment from a customer to an employee for great service. To qualify, it must:

• Be given freely by the customer

• Be an amount the customer chooses

• Not be negotiated or set by the employer

If it doesn’t meet these standards, it may be considered a service charge—which the IRS treats very differently.

2. Tips vs. Service Charges

Under IRS rules, service charges—such as automatic gratuities for large parties or mandatory event fees—are not considered tips. These amounts are part of the business’s gross receipts, which means the employer can retain them or distribute them as wages. They must be reported as regular wages, subject to withholding.

Quick Reference:

3. Who Can Participate in a Tip Pool?

Under federal law, only employees who regularly receive tips—such as servers, bartenders, or salon stylists—can participate in a mandatory tip pool.

Managers and supervisors are generally excluded, even if they perform tip-eligible work, unless they spend a substantial amount of time (more than 20%) directly serving customers.

4. Dual-Role Employees and Shift Leads

For employees who work in both tipped and non-tipped roles (for example, a server who also works as a host), employers must ensure tips are only shared based on the hours worked in the tipped role.

Shift leads who have some supervisory duties may still participate in tip pools if they primarily perform the same tip-eligible work as their coworkers.

5. Best Practices for Compliance

To avoid payroll tax issues, disputes, and penalties:

• Keep clear records of all tip pooling arrangements

• Communicate policies to employees in writing

• Separate tips from service charges in your point-of-sale system

• Stay updated on both federal and state-specific tip laws

The Bottom Line

Tip pooling can be a fair and effective way to share earnings among employees—if it’s done correctly. By understanding the rules, you can keep your business compliant and maintain trust with your team.