Philadelphia Updates Wage Tax Return to Enable Reporting of Tip Income and Prevent Overassessment of Wage Tax Against Restaurant Employers

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June 17, 2016

A recent change to the Philadelphia Wage Tax Return addresses an issue that has plagued restaurants with tipped workers subject to the Philadelphia wage tax, yet the change to correct this issue has gone largely unnoticed by some restaurants.  Restaurants that operate within Pennsylvania and employ Philadelphia residents have historically been assessed for wage taxes they could not withhold and subjected to penalties and interest imposed by the City of Philadelphia for failing to withhold the Philadelphia wage tax on tip income earned by tipped workers.  These penalties were not only surprising, but also unjustified in many cases, given that restaurants often cannot withhold the full amount of the wage tax required by Philadelphia law.  Under the stacking rules that apply to wage withholding, employers must withhold taxes in a predetermined order prescribed by law, beginning with FICA taxes, then Federal income taxes, then state taxes, and lastly, local taxes.  Local taxes, such as the Philadelphia wage tax, often cannot be withheld because there is simply no money left after Federal and state taxes are taken out.  However, employers have been repeatedly punished with underpayment penalties imposed by the Philadelphia Department of Revenue with respect to the Philadelphia wage tax.

To rectify this situation, the City of Philadelphia has updated its Wage Tax Return, such that the 2015 version now provides on Line 3 an opportunity for employers to report the tip wages earned by employees on which the Philadelphia wage tax could not be withheld. The instructions to the 2015 Wage Tax Return explain that the employer should report the amount of tip income reported to the employer by the employee and any other tips allocated to the employee by the employer—the withholding liability is based only on wages under the employer’s control (other than tips) and amounts turned over voluntarily by the employee to the employer.  This is a welcome change by the Philadelphia Department of Revenue that addresses an issue that has caused significant headaches for many restaurants.