You must understand how to properly report this income to maintain tax compliance, since tips are considered taxable income that must be reported both to your employer and the IRS. This article explains in greater detail how to report tips and cash payments correctly so you can fulfill your tax requirement.
Comprehension of what is tipped
Tips are numerous types of gratuity given by customers for services rendered. They include:
- Direct cash tips from customers
- Customer tips rendered electronically (credit cards, debit cards, gift cards)
- Cash equivalent of non-cash tips, i.e., tickets or other items of value
- Tips received by other employees through tip pools or tip-sharing arrangements
It’s worthwhile to differentiate tips from service charges. Service charges, like automatic gratuities placed on big party bills, bottle service, or delivery charges, are not tips but usual wages and will usually be counted on your paycheck instead of paid at the conclusion of your shift.
Keeping track of your tips
The IRS asks employees to keep a daily record of tips received. Keeping this record is required for proper reporting and can help you in the event of an audit:
- Keep tips daily on an individual record system
- Keep the date, amount, and source of each tip
- If you are part of a tip pool, record what you receive after pooling
- You might find it helpful to use IRS Form 4070A, “Employee’s Daily Record of Tips,” to make it simpler to keep track
Maintaining accurate records prevents you from underreporting or overreporting your tip income, both of which can get you into tax trouble.
Reporting tips to your employer
If in any month you receive $20 or more in tips, you are required to report them to your employer on or before the 10th day of the next month. Tips earned in January, for instance, are to be reported to your employer by February 10th.
- Use IRS Form 4070, “Employee’s Report of Tips to Employer,” for reporting on a monthly basis
- Report all cash tips and electronic tips received
- Report the amount actually received after tip-sharing if applicable
- Tips less than $20 per month from one employer do not need to be reported to that employer
- Your employer will report your reported tips on your W-2 form in Box 7 (Social Security tips).
Tax obligations for tip income
All tips are taxable, both federal income tax and whether they need to be reported to your employer:
- Your employer will take out Social Security and Medicare taxes, as well as income tax, on tips you need to report
- You’ll pay these taxes on tips you don’t need to report on Form 4137, “Social Security and Medicare Tax on Unreported Tip Income”
- Even if tips are under $20 a month, they will need to be reported on your return
Keep in mind that your employer has to determine that reported tips are at least 8% of total food and drink sales. When employees in total report less, restaurants with over 10 employees must split the difference between employees, which will show up on your W-2 in Box 8 (Allocated tips).
Special situations in tip reporting
There are specific situations in which you’ll have to change the way you report tips:
- If you maintained accurate daily records indicating your actual tips differed from the tips allocated to you, you could report your actual amount
- If you have more than one employer, the $20 reportable limit applies to each employer
- Non-cash tips are taxable as income but not Social Security or Medicare tax
- Keep in mind that underreporting tip income can result in penalties and interest charges if found during an audit.
By using these guidelines, you can accurately report your tip income and comply with your tax requirements without risking potential trouble with the IRS.
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