10 Questions When Filing Taxes With Tip Income

You're probably racking up tip income with tricks like that. Make sure you know how to report it correctly to the IRS.
You're probably racking up tip income with tricks like that. Make sure you know how to report it correctly to the IRS.
.stock/iStock/Thinkstock

If your first question about filing taxes with tip income is, "Uh, how do I file taxes with tip income?" then you're in the right place. Unless you're an expert tax filer -- or you just have an amazing long-term memory that allows you to recall your detailed tax returns from year to year -- you probably do need a primer on ways to give your tip money to Uncle Sam.

And unlike obnoxious customers who wink at you and tell you their tip to you is to invest in plastics, we have some real advice. Not only will we cover what counts as a tip (and where to count it on your return), but we'll also give you an idea of the best ways to keep track of that income so you don't find yourself guessing, come April.

So how does cash count? Read on to figure out the basics.

10: Is this cash a tip?

At the end of a long day, there is nothing more satisfying than happily flipping through your fresh pile of hard-earned cash. While salaries can be more reliable, and wages might be steady, tip money is nothing to scoff at. For a lot of service workers, it's the income that pays the rent and buys the food. (And for the lucky ones, it pays for that HBO cable package too.)

But what actually constitutes a tip? We'll explore a few options, but the most important is plain old money. Any cash tips -- and that also includes credit and debit tips, which are usually cashed out -- are going to need to be reported as income. There really aren't a lot of exceptions to that rule; you're pretty much obligated to report any tips collectively over $20 a month to an employer. Next? Let's ask why you need to tell your boss about the tips you earn.

9: Do I really have to tell my boss my tips?

As we said, you really do need to tell your boss about the tips you receive. It's not about just making her aware of your stellar service. The boss-person actually needs the number to make sure your tax withholdings are correct. Remember that an employer is taking money out of your wages to help pay your taxes; if the employer is just using an hourly wage, that's not going to be enough to cover the tips you made as well.

If your tax is only withheld on your hourly wages and you also report your tip income on your tax return (which you have to do), you'll have a whopping tax bill come April. That's why receiving more than $20 in tips monthly must be reported to your boss (and if you make less than $20, you'll still have to report it on your return) [source: TurboTax Unreported].

8: Do I need to count the money I tip out to the busser?

It would be really great if all tips were cash and given directly to you. (Add to that wish list that they would be "substantial" and "frequent.") Unfortunately, sometimes they aren't always as straightforward. We'll look at a few examples of ways that your extra income can make it to your pocket -- and how it needs to be recorded on your tax return.

We'll start with a pretty common issue: tip pooling or splitting. While some servers can simply pocket whatever money the customer leaves on the table, a lot of service industry professionals put all the tips into a big pot. They're then given a share of the money earned that night. You might also give a certain amount of your own tips to a busperson or barback who never directly pockets a customer's cash.

Only report to your employer the income you receive from tips [source: IRS Reporting]. If you make a $15 tip on a table and give $5 to the busser, you only have to report $10. Similarly, you only report the fraction of the pool you receive at the end of the night.

7: Is this free ticket to the baseball game a tip?

Tips can get even more complicated when you're receiving some other compensation besides cash for your services. While it may seem like you're getting away with something, there's nothing wrong with accepting noncash tips from customers or clients. (At least according to the IRS. Your boss may have other ideas.) If a regular knows you love baseball and tips you some decent box seats for the game, don't turn the tickets away.

In fact, you don't even have to report it to your boss as income. It's yours to walk away with. But here's the rub: You still have to report it to the IRS. On your W-2, you'll need to add the value of any noncash tips you receive to your wages and compensation. (We'll go over the forms more in-depth later.)

But we're still not out of ways that tips can come in strange packages. Let's check out another vague tip situation.

6: Is this service charge a tip?

As we've said, not every job in the service industry has the same standard operating procedure for how tips are allocated or calculated -- and even those might not be across the board, but have exceptions of their own. Either way, you'll need to keep track of them carefully or else you might find yourself overpaying your taxes.

Service charges are a great example of why you need to keep an eye on your tips for tax purposes. Many restaurants might include a service charge for larger parties -- say, a 15 percent extra charge for more than six customers. Basically, it's the restaurant enforcing a tip on groups. And because it's mandatory, you don't have to report it to your boss as extra income. It should be included in your wages, not as a tip. If the customer has a choice about whether to leave money or not -- or has the right to decide who to leave the payment to -- it's a tip. Otherwise, it's a service charge.

More Questions When Filing Taxes with Tip Income

Big restaurants may opt for allocated tips. If they do, they, not you, are responsible for reporting them.
Big restaurants may opt for allocated tips. If they do, they, not you, are responsible for reporting them.
wx-bradwang/iStock/Thinkstock

5: Do I have to pay taxes on allocated tips?

To round out our "what do I do with this weird tip?" section, let's talk about allocated tips. These tips are not typical, so if you're wondering if they apply to you, they probably don't. They're basically tips that your boss or employer gives you in addition to any tips you normally make, and this category is designed to make sure all tips are being fairly reported.

This might happen if you work in a large restaurant. Your boss might take a percentage (usually about 8 percent) of the restaurant's sales and subtract it from the reported tips everyone made that month. If the boss sees that the reported tips are less than the 8 percent figure, he can allocate more money to servers to make up for the underreporting [source: Bell]. In other words, if your boss sees the servers should have made at least $5,000 in tips but only $4,000 was reported, you might get allocated a portion of that $1,000 dollars.

The good news? If you received allocated tips, your employer is responsible for reporting them. They'll show up in box 8 of your W-2, if you have them [source: IRS Reporting].

4: How do I keep track of tips?

Now that we know all the strange and wonderful tips we can receive and how to report them, you might be wondering how it is you're supposed to keep track of the spare quarters, crumpled bills and random IOUs that customers leave as tips. (And if they are leaving IOUs, find another job.)

The IRS -- and likely any tax professional -- is going to recommend you bite the bullet and actually write down any tip you get. In fact, they even have a handy form (Form 4070A) to help you itemize the tips that come your way [source: IRS 1244]. You can keep track of your tip amounts, any tips that are paid to you by other employees in a pool and any tips you're paying others for their share of help.

There's no obligation to use 4070A, but you should keep written track of your tips in some way, regardless. The IRS is not a mean group, but the agency does not take kindly to taxpayers underreporting income. It knows how much you should be making (and reporting) as tips on your taxes. Be sure to keep that tip diary for three years, which is a general statute of limitations on audits [source: Phillips Erb].

3: What form should I fill out to report my tips?

A lot of us get a little nervous about IRS paperwork. We don't want to misreport on accident, and sometimes it can be a bit nerve-racking to determine if we even have the right form. But there's no need to get too freaked; The IRS may have lots of paperwork at its disposal, but remember that it's designed so that you can easily report your specific position. No matter what situation you find yourself in, the IRS should have information to cover you.

For tip income, it's as easy as can be. When it's time to fill out your 1040, you'll report it on line 7 of your return. And as long as you've been reporting tips to your employer, you can even just look on your W-2, where they'll be recorded. Speaking of reporting, you can also fill out Form 4070 (not to be confused with 4070A, your tip diary.) Form 4070 simply helps you keep track of the tips you report to your employer [source: IRS 1244]. You don't have to use it, but it might help you ensure you're not forgetting any tips or overreporting.

2: What's the Tip Rate Determination and Education Program?

The IRS is just as interested as you are that income is reported fairly and correctly. The agency has no desire to tie up its own resources and time to audit an employee or company, so it's in everyone's best interest to report wages the right way. You might work for a company that is taking part in the Tip Rate Determination and Education Program, which means that it's agreed to track tips and report them a certain way.

The program actually consists of two plans in which an employer can choose to participate. One, the Tip Rate Determination Agreement (TRDA), involves the employer working with the IRS to establish tip rates for various jobs. The Tip Reporting Alternative Commitment (TRAC) asks the employer to establish independently procedures for employees to correctly report their tips. TRDA does make an employee sign an agreement to participate in the program, but TRAC's responsibility lies primarily with the employer. Your employer will let you know if it is participating in either program [source: IRS].

1: Honestly, is it really so bad if I don't report my tips?

Honestly, it is so bad.

Remember that tips aren't just "extra" money. Tips absolutely count as your income. Not reporting income to the IRS pretty much equals tax evasion, and the IRS is fairly well-known for making it the agency's business to punish those who evade taxes. If you don't report your tips, be prepared for some consequences.

One biggie? You might get audited. That means you're not just going to have to provide records, receipts and information for your tips -- you're going to have to comb through all your finances with the IRS. Second, you'll obviously have to pay the taxes you owe on your tips. And third, you're subject to a penalty equal to half the cost of the Social Security, Medicare and whatever else you owe on your unreported tips.

For more answers to questions about taxes and income, read on to the next page.

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Author's Note: 10 Questions When Filing Taxes With Tip Income

While we talked about a few rather complicated scenarios, do keep in mind that tip income -- by and large -- is pretty easy to keep track of and report. The key, however, is actually keeping track and reporting it. Giving ballpark estimates or assuming wages isn't going to cut it.

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Sources

  • Bell, Kay. "Don't Forget: Tips Are Taxable Income." Bankrate. Feb. 22, 2008. (Nov. 3, 2014) http://www.bankrate.com/finance/money-guides/don-t-forget-tips-are-taxable-income-2.aspx
  • Internal Revenue Service (IRS). "Publication 1244." August 2005. (Nov. 3, 2014) http://www.irs.gov/pub/irs-pdf/p1244.pdf
  • Internal Revenue Service (IRS). "Reporting Tip Income." 2013. (Nov. 3, 2014) http://www.irs.gov/pub/irs-pdf/p531.pdf
  • Internal Revenue Service (IRS). "Tips on Tips." 2006. (Nov. 3, 2014) http://www.irs.gov/pub/irs-pdf/p3144.pdf
  • Phillips Erb, Kelly. "Taxes from A to Z." Forbes. April 3, 2014. (Nov. 3, 2014) http://www.forbes.com/sites/kellyphillipserb/2014/04/03/taxes-from-a-to-z-t-is-for-tip-income/
  • TaxAct. "'Tips' for Tip Income." 2014. (Nov. 3, 2014) http://www.taxact.com/tax-information/tax-topics/tips-for-tip-income.asp
  • TurboTax. "How to Claim Tips on Your Tax Return." Intuit. 2013. (Nov. 3, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/IRS-Tax-Return/How-to-Claim-Tips-on-Your-Tax-Return/INF14782.html
  • TurboTax. "When to Use Tax Form 4137: Tax on Unreported Income." Intuit. 2014. (Nov. 3, 2014) https://turbotax.intuit.com/tax-tools/tax-tips/Taxes-101/When-to-Use-Tax-Form-4137--Tax-on-Unreported-Tip-Income/INF19257.html