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How Are Tips Taxed, Recorded and Reported?

How Are Tips Taxed, Recorded and Reported?
Ines Zemelman, EA
17 December 2021

There are many types of tips. Customer tips are usually left in the form of a credit card, a debit card or cash when a check is paid. Tipping also includes non-cash items such as gift cards or tickets to sporting events.

When you receive something with value, it is:

  • not compulsory
  • discretionary
  • not mandatory according to company policy, or customer who receives payment determines

is regarded as a tip. If a customer has the option of leaving money and can choose which person to leave the money to, then it's a tip.

Additionally, any money distributed or shared with other employees may be considered a tip. A tip pool is considered a tip if your employer distributes money indirectly to tipped employees.

Are Tips Taxable Income?

Taxes are imposed on tips since they are considered a form of income. So, how are tips taxed? Your employer is required by law to withhold enough funds from both your hourly wages and your tips to cover your income, Social Security, and Medicare taxes. Nonetheless, it is your responsibility to report your tips.

If you receive tips directly from the customer, the amount withheld from your paycheck is determined by the sum of your wages plus the tip income that you report. Your employer will need to know the total amount of tips received every month if you keep an accurate record of them every day.

What Constitutes A Taxable Tip?

There are several types of tips that must be reported and taxed:

  • A number of cash tips that totals more than $20 in a month.
  • Credit cards, debit cards, and gift cards as payment methods for electronic tips.
  • You receive tip pools, tip splitting, or similar arrangements as a result of other employees tipping you.

What Tips Are Not Required To Be Reported?

Your employer does not require you to report tips if you haven't earned $20 during a month. When preparing your tax return, you still need to include these tips in taxable income. Apply the $20 limit to each job you hold if you work more than one.

Also, tips that aren't cash, such as tickets or other valuable items, aren't required to be reported.

How Does Tip Sharing or Tip Pooling Work?

If you share some of your tips with other employees, you will reduce the total amount of tips that need to be reported. Hence, reduce your taxable income. You only have to report $200 in tips if, for example, you receive a $250 tip and give fellow colleagues $50.

Sometimes your employer may allocate tips to you. In such case, the allocated tips will appear separately in Box 8 on your Form W-2.

What Is the Procedure for Reporting Auto-gratuities and Surcharges?

Service charges or large party charges may be added to customers' bills by some employers. Due to the fact that the customer did not select or determine the person who should be paid, this is not regarded as a tip by the IRS. This means your employer does not need to be aware of these charges. You will be paying income tax, Social Security tax, and Medicare tax on that income already since your employer includes the amounts from those charges in your paycheck.

Can Food Service Employees Deduct Work-Related Expenses From Their Taxes?

The federal government no longer allows the deduction of unreimbursed employee expenses unless you itemize them in your federal tax return. There are some states, however, that still allow you to deduct state taxes if you qualify.

Unreimbursed expenses that exceed 2% of your adjusted gross income may be eligible to be deducted if you do not take the standard deduction but instead itemize. It is imperative to note that not claiming tips on taxes is against law. The following requirements must be met to claim these expenses:

  • The uniforms you wear at work only if they're necessary for your employment and not for everyday wear
  • Licenses, classes, or certifications
  • To get the job done, you must have the right tools and supplies
  • Accommodations, meals, entertainment, and transportation related to your occupation

In most food service establishments, employees are employed, not independent contractors. It is usually an employee rather than an independent contractor if the payer directs the type of work to be performed and how it will be performed. If you have a second job as an employee or as a gig worker, you may get into trouble for not reporting to IRS on time.

What’s the IRS’s Procedure for Reporting Tips?

In most cases, IRS requires you to inform your employer of your total tips by the 10th of the following month. Using IRS Form 4070, any employee who has received tips can report them to their employer if their employer doesn't have a process for reporting tip income. However, if all of the following are included in your report, you are not required to use that form.

  • Identify yourself by giving your name, address, and Social Security number
  • Adding your signature
  • Name and address of your employer
  • Reporting month or reporting pay period
  • Tip totals received during that time frame

For tip withholding, your employer will inform the IRS and withhold money from your paychecks.

Is There Any Way To Report Unreported Tip Income?

When filing income taxes, you may not have reported tip income in some cases. For example, when you received non cash tips from customers or if you received tips that totaled less than $20 per month. Use IRS Form 4137 to report such amounts. You will find instructions in Form 4137 on how to calculate the social security and Medicare taxes you must pay on tip income that is not reported.

When Tips Are Not Reported Accurately, What Penalties May Result?

You could be subject to a penalty equal to 50% of any unpaid Social Security and Medicare taxes if you fail to report your tips to your employer. The IRS Form W-2 also shows how much tax you still owe if you weren't paid enough in wages and tips to cover your tax withholding by your employer. The penalties for underpayment of tax are assessed after your tax return has been filed if the amount is significant.

Are There Any Employee Responsibilities?

If you receive tips, there are three things you should do:

  • Tip receipts must be recorded on a daily basis by employees. The Employee's Daily Record of Tips must be reported on IRS Form 4070A, included in Publication 1244. As well as providing the information on the Form 4070A, you also need to keep a record of any tips you receive that are not cash, such as tickets, passes, or other similar items.
  • Unless your total tips for the month are less than $20 per employer, you must report tips to your employer.
  • Using Form 4137, an employee must report any unreported tip income to include on their Form 1040 or 1040-SR as additional wages, as well as their share of social security and Medicare taxes.

What Are Employer Responsibilities for Reporting Employee Tip Income?

Taxes withheld from an employee's wages, Social Security taxes and Medicare taxes, along with the employer's share of both, are reported on Form 941. The federal government requires employers to deposit these taxes.

Ines Zemelman, EA
Founder of TFX