Tips and gratuities: a payroll checklist for Ontario employers

Start by sorting each tip: controlled or direct

Everything about how tips are treated for payroll depends on one question: who controls the money? The CRA treats tips as employment income either way, but only some of them are payroll amounts you must withhold on and report.

Controlled tips are tips you possess or control and then pay to the employee. The CRA’s examples include a mandatory service charge added to a bill, a percentage you add to a bill to cover tips, tips shared by a formula you set, tips staff hand to you to distribute, and cash tips deposited into the business account or mixed with its money. Direct tips are paid by the customer to the employee, and you have no control over the amount or how it is shared. Examples include cash left on a table, a tip handed to a porter, a pool that employees (not you) decide how to split, and a card tip you return to the employee in cash at the end of the shift.

Write down which of your tip arrangements fall into each group. If staff receive both kinds, treat each type separately. Where an arrangement does not clearly fit, such as tips that sit in your bank account for a few days before payout, ask your accountant before the first pay run rather than after the first T4.

What to withhold and what to report

For controlled tips, the CRA says you withhold income tax, EI premiums and CPP contributions, in the same way as for other pay. On the T4 slip, controlled tips go in box 14 (employment income), box 24 (EI insurable earnings) and box 26 (CPP pensionable earnings). The employee reports them on line 10100 of their return.

For direct tips, you do not withhold income tax, EI premiums or CPP contributions, and you do not report the amounts on the T4. The employee is still required to report them as income, on line 10400. The CRA adds that an employee can choose to pay CPP contributions on direct tips from pensionable employment by filing Form CPT20 with their return, so mention it to employees who ask why their CPP record looks lower than their earnings.

Here is an illustration with round numbers. Suppose a server receives $500 of controlled tips in a pay period and $200 of direct tips left on tables. The $500 is added to that period’s pay for withholding and shows up in the T4 boxes above. The $200 is outside payroll, but the server still reports it. The CRA’s page also describes declared tips, which apply only in Quebec, so they do not arise for an Ontario workplace.

Ontario rules on keeping, pooling and paying out tips

The Employment Standards Act, 2000 is a separate set of rules from the tax rules, and both apply. Ontario’s guide says an employer generally cannot withhold, deduct from or make an employee return tips or other gratuities, except as the Act permits. A payment you impose as a service charge can count as a tip when a reasonable person would believe staff keep or share it. Tips are not wages, so they are left out of minimum wage, vacation pay, public holiday pay, termination pay and overtime calculations.

Deductions for spillage, breakage, losses or damage are not allowed, and employees cannot agree to them in writing or verbally. Only three kinds of deduction are permitted: those required by statute (such as income tax, EI and CPP, and only if the money is remitted), court orders, and tip pooling. For card tips, the guide allows you to take back part of the credit card processing fee, being the greater of the tip multiplied by the card company’s percentage or the tip multiplied by 1.5%. It does not allow deductions for debit or any other processing fees.

A tip pool redistributes tips among some or all employees. Contributions can come only from tips, so a server who receives no tips contributes nothing, even if a formula based on sales would suggest otherwise. As a rule, managers may keep their own tips and may usually join a pool if your policy allows. You may share in a pool only if you are a sole proprietor, partner, director or shareholder who regularly does substantially the same work as the employees who share in it, or as employees of other employers in the industry who commonly receive tips.

Pay tips out properly and post the policy

Since June 21, 2024, Ontario employers must pay tips by cash, cheque or direct deposit, which includes Interac e-Transfer. For cash or cheque, payment is at the workplace or another place the employee agreed to in writing, including electronically. For direct deposit, the employee chooses the account and it must be in the employee’s name. If staff were previously required to use a particular bank, confirm their chosen account before the next payment.

The Act sets no fixed payout schedule, but an unreasonable delay can count as withholding tips, so set a regular rhythm and stick to it. If you, or a director or shareholder, share in a tip pool under a written policy or a consistent practice, you must post a copy where employees will see it, post any revised version, and keep a copy of every posted policy for three years after it stops being in effect. An unwritten practice has to be put in writing first. Using a third party to process tips is allowed, but you remain responsible for compliance.

Records, common mistakes and when to ask for help

Keep a simple tip log for each pay period: total controlled tips, how they were calculated, the pool formula, each person’s share, the payout date and method, and the amount withheld. Make sure the payroll report agrees with the ledger so your accountant can reconcile payroll liabilities to remittances.

The mistakes that come up most often are treating all tips as direct because they come in on a card terminal, paying out controlled tips without withholding, deducting breakage from a server’s tips, forgetting to put CPP and EI earnings in the right T4 boxes, and pooling by a sales formula that takes more than the tips received. If you find a past error, ask for advice on correcting it instead of quietly adjusting the next cheque.

Bring to a conversation with an accountant your tip policy, the way card tips are collected and paid, sample pay stubs and your last T4 summary. Related guides on this site cover your first payroll set-up and common business expenses, and the payroll service page explains how Sora can help with the process.