Tips - W-2 comp definition - safe harbor match per payroll

[Belgarath]

We don't have many clients where tips are an issue, so this hasn't come up.

So, plan defines comp as W-2. It does not exclude tips - which would likely be discriminatory anyway. The safe harbor match is an enhanced 100% up to 4%. It is calculated on a per payroll basis.

I'm fine with understanding that you can't defer on tips, (these aren't pooled tips) cause the employee has already received them. But the employees have to report their tips to the employer, who will then include them on the W-2 as taxable, etc., at the end of the year.

How does this mesh, in real life, with the safe harbor requirement? Is there a citation for not including the tip income in this situation when calculating the match?

It would seem like if the tip income is reported to the employer regularly, then a match would be based upon the total income, including tips, for that payroll?

Example - employee has a 10% deferral election. For a given paycheck, EMPLOYER compensation is $500, and there is $500 of tip income, for a total reportable amount of $1,000. So employee deferral for that payroll is ($500 x 10% = $50). Is the safe harbor match on that payroll ($500 x 4% = $20) or is it ($1,000 x 4% = $40?) I lean toward the $40 since I don't see a legitimate basis for excluding it, yet it seems like an absurd result.

For an employer Profit Sharing contribution, it seems like it would be based upon total compensation, so it would be based upon the $1,000 when it is eventually made - agree? Disagree?

[ETA Consulting LLC]

I don't think I would be fine with saying that you cannot defer tips. I did some reading on this about 10 years ago. There has to be a process put in place to allow for a server to defer their tip income; an obvious exception to the rule stating that you may not defer from Compensation you've already received.

Good Luck!

[Belgarath]

Thanks for the response.

I can see how this would work in a pooled tip situation. But I'm having difficulty seeing how it could be reasonably managed in a non-pooled cash tip situation.

I can't find a citation for where an employer is REQUIRED to provide for a deferral procedure on cash tips, although I can see why it would be reasonable to somehow require it. Do you know of any specific guidance/citations? I checked IRS Pub. 531, but this wasn't any help. Anyone have any practical solutions to this thorny problem, that have been blessed by the IRS?

I saw one "solution" proposed where tips were excluded from the plan definition of compensation, but there are HC's involved who receive zero tip income, so this would be a discriminatory definition of compensation.

As to the other question, do you think the match would be the $20 or the $40?

[Belgarath]

P.S. - I know this is a very old reference, but possibly useful nonetheless:

From the Pension Actuaries and Consultants Conference in Washington, D.C., on October 9, 1997:

ASPA: A 401(k) plan is established by a restaurant. Under IRS rules, the restaurant is required to add tip income to the W-2 of the employee. An individual employee elects to contribute to the 401(k) plan but the amount of the designated deferral is greater than the participant's paycheck (base salary) from the restaurant due to the very large tip income, but still less than all applicable limits for deferral. Is the employee able to give the additional funds to the employer for depositing into the plan? It seems perfectly acceptable, but acknowledgment from the Service would be very helpful in a number of cases that already exist.

IRS: The employee is NOT able to give the money back to the employer and have them deferred into the 401(k) plan. If the employer collects the tips (such as on a credit card slip), then it can still be deferred. But if the employee has the funds, then it is too late to defer it since the employee already has it. The amount of the deferral cannot be more than the amount of the actual check.

[Kevin C]

If they don't allow deferrals from tip income, I think you would have a problem with universal availability for the catch-ups under 1.414(v)-1(e)(1), particularly with the effective opportunity rules under (i).

I couldn't find anything directly relating to deferrals in your situation with a quick search. I did see something saying the employee can give the employer additional funds for tax withholding if the paycheck isn't enough to cover it in Pub 531. Not sure if that helps here.

From your example, if the participant has $50 of deferrals and $1,000 of plan comp for the pay period, under your match formula (100% on the 1st 4%), the match would be $40. But, I also wonder what the deferral election says. He/she elected to defer 10% of what?

[Belgarath]

Thanks Kevin. Yeah, isn't this fun? I also saw the tax withholding piece in the Pub. 531, but I agree, that doesn't help here.

For credit card tips, I think everything works fine. They are run through payroll as regular wages. It is just the cash tips that are turning everyone's hair gray. Your point about universal availability for catch-ups is well made, but I suppose a pretty reasonable argument can be made that the cash tips, once received, cannot be "paid" to the employer for subsequent deferral.

On a less theoretical basis, looking at what actually happens in "real life" - I suspect there are very few employees who truly report 100% of their cash tips. I can't imagine that even if allowable, they would take income that escapes tax reporting altogether, and pay it back to the employer just so they could have the opportunity to defer taxes (and later pay them) on income they wouldn't otherwise report anyway! But I suppose they might want to for all or some of the amount that they actually do report...

Oh well, I guess we'll just have to give it our best shot, and let the employer decide what is "reasonable." Employers virtually NEVER listen to our recommendation to discuss with ERISA counsel prior to making such a decision.