More Questions When Filing Taxes with Tip Income
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.
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.
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.
- 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
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.