Taxes on Tips

If you receive tips, you should keep a daily record of them and report them to your employer in order to obtain your social security and Medicare coverage and to avoid a penalty. You must also report all your tip income on your income tax return.

The tips you receive from customers in your work as an employee are considered “employee compensation” and are subject to U.S. income tax.  It includes cash tips you receive directly from customers; it also consists of the tips on credit card payments that are paid to you by your employer, and your share of allocated tips.  If you receive any items of value other than cash, such as tickets or passes, these are also subject to income tax, but not to social security and Medicare tax.

Keeping Track of Your Tips

You should keep track of your tips on a daily basis, using a diary or other record of your own.  If you use your record, it should show your name, your employer’s name, and the name of the business, if it is not the same as your employer’s name.  Then for each date, you should record the cash tips you receive directly from customers or that you receive from other employees, tips from credit cards that your employer pays you, items of value other than cash that you receive as tips, and the amount of tips you pay other employees and their names.  Service charges that your employer adds to customers’ bills and then settles to you are not tips.  You need to report them as wages, and therefore you should not include it in your record of tips.

IRS Form 4070A

You can also use a form provided by the Internal Revenue Service (IRS) – Form 4070A, called “Employee’s Daily Record of Tips.”  Your employer may have this form, or you can obtain it from IRS Publication 1244 – “Employee’s Daily Record of Tips and Report to Employer.”  You can download this publication from the IRS website.  The release is also available in Spanish – 1244(PR).  The form is designed to record the information described above.

Reporting Your Tips to Your Employer

You need to inform your tips to your employer to ensure that all your employee compensation, including your tip income, is subject to social security and Medicare tax.  It will affect your income if you ever become disabled, and will also increase your social security benefits when you retire.  The tips you need to report, for this purpose, include cash, checks, and tips from debit and credit cards.  You do not need to report items of value you receive as tips, such as tickets, to your employer.  These types of tips are not subject to social security and Medicare tax.  But you should still include these items on your tip record since they are subject to income tax.

You should report tips to your employer whenever you receive over $20 in any given month.  If you earn less than that amount, you do not need to inform them.  If you work for more than one employer, the $20 limit applies to each employer.

IRS Form 4070

Your employer may give you a specific form to use for reporting your tips.  Your employer may also ask you to state your tips more often than once a month and may ask you to report them electronically.  But you must report tips at least monthly (provided you have more than $20 to report).  If your employer does not give you a form to use for reporting tips, you can use IRS Form 4070 – “Employee’s Report of Tips to Employer.”  This form is also in IRS Publication 1244.  You should give this form to your employer by the 10th of the following month and should keep a copy for your records.

The penalty for Not Reporting Tips

If you do not report your tips to your employer, you could be subject to a sentence of 50% of the social security and Medicare tax that applies on the unreported tips.  This penalty is in addition to the taxes you would owe on the tips.

Giving Your Employer Money to Cover the Tax on Your Tips

It may turn out that the amount of tax your employer withholds from your pay is not sufficient to cover the social security and Medicare tax that applies on your regular payment plus the tips you report.  If this is the case, you can give your employer money to cover the difference.  If any social security and Medicare taxes remain unpaid at the end of the year, you will have to report them on your income tax return.  You will show these uncollected taxes in box 12 of your Form W-2 for the year.

Reporting Your Tips on Your Income Tax Return

Your employer reports your tips along with your salaries and wages on line 1 of Form 1040EZ, or on line 7 of either Form 1040A or 1040.  If you kept a tip record and reported your tips to your employer, the amount that you would have to add to the amount shown in box 1 of your W-2 are the tips of less than $20 in a month, and the amount for items of value that were not cash, since you did not have to report either of these.  But they still must be included on your income tax return.

Tips You Did Not Report to Your Employer

If you have tips that you should have reported to your employer, but you did not report them, you will have to report the social security and Medicare tax on those unreported tips on your income tax return.  In this case, you will have to complete Form 4137, Social Security and Medicare Tax on Unreported Tip Income.  Form 4137 must be attached to your income tax return, and the tax calculated on that form is reported on the separate line for those taxes in the “Other Taxes” section of Form 1040.

Uncollected Social Security and Medicare Taxes

If your employer was not able to withhold all your social security and Medicare taxes from your regular pay and the taxes you reported, and you did not give your employer money to make up the difference, then you need to state these uncollected taxes on your income tax return.  In this case, you must file Form 1040, and not Form 1040EZ or 1040A.  You should include the taxes in the line for total taxes (line 62 of Form 1040), and you would write “UT” and the amount of the uncollected taxes on the dotted line beside the total taxes amount.

Allocated Tips

Allocated tips are tips that your employer assigned to you, in addition to the tips you reported.  It may occur if you work in a restaurant, cocktail lounge, or similar establishment that must allocate tips to employees, and when the tips you reported to your employer are less than your share of 8% of food and drink sales.

These allocated tips are shown separately in box 8 of your Form W-2, and in the total, in box one, it doesn’t include.  You can calculate allocated tips by subtracting the total tips reported by all employees from 8% of complete food and drink sales.  Your proportionate share of that amount is estimated based on an agreement between the employer and the employees, or according to an IRS method, based on the employees’ sales or hours worked.

Do You Have to Report Allocated Tips?

You must report allocated tips on your tax return unless one of two exceptions applies.

  1. You kept a daily tip record or other evidence that is as credible and reliable as a regular tip record.
  2. Your tip record is incomplete, but it still shows that your actual tips were more than the tips you reported plus the allocated tips.

If one of the two exceptions applies, you should report your actual tips and exclude the allocated tips from box 8 of your W-2.

How To Report Allocated Tips

If you have to report allocated tips, add the amounts in boxes 1 and 8 of your Form W-2 and report the total on the wages, salaries, tips, etc. line (line 7) of Form 1040.  You cannot use Form 1040EZ or 1040A in this case.

Since social security and Medicare taxes are not with the allocated tips, you will have to calculate these taxes on Form 4137.

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