If a food and beverage establishment with 10+ employees reports total tips below 8% of its gross receipts for the year, the IRS requires the employer to "allocate" the shortfall among directly tipped workers. The allocated amount shows up in Box 8 of the W-2.
The allocation formula uses either:
- Hours worked at the establishment
- Gross receipts attributable to the worker
- A "good faith" method agreed between workers and management
Allocated tips are NOT automatically taxed. They appear in Box 8 but are excluded from Boxes 1 and 7. You're responsible for either:
- Including the allocated amount in your tip income on your 1040 (and paying tax + FICA via Form 4137), OR
- Proving you actually earned less by maintaining contemporaneous records (a daily tip log)
The 8% threshold is national. If the IRS approves an employer's petition, it can be lowered to as low as 2% — but only with worker consent and documentation. Most restaurants don't bother petitioning.
Best defense against allocation: report tips accurately throughout the year. Box 8 = $0 when reported tips reach 8% of sales.