If you work as a waiter, it feels great to have a wad of cash in your pocket at the end of your shift. However, you need to remember that tips are considered part of your income -- which means they're taxable in the eyes of the IRS. Failure to report your tips can prompt the IRS to come calling, and that's a situation everyone wants to avoid.
Reporting tip income isn't the most complicated thing in the world, but it does require some careful record-keeping and communication with your employer. When it comes to dealing with the IRS, more records and details are always better than less. Understand the tax laws up front and find out from your employer what's required of you. That way you won't be met with any unpleasant surprises come tax time, and can continue to use the money you've worked so hard to earn.
Continue reading to learn more about how tip income works, and how to report it on your taxes.
Tips Are Wages, Too
Every tip you receive as part of your job counts as taxable income. This includes cash, credit cards, debit cards, tip sharing at work, and, believe it or not, the cash equivalent of things likes concert or sport tickets given to you as tips. If you receive more than $20 a month in tips, you're required to report that money to your employer each month. Your employer then withholds federal income tax, Social Security, and Medicare from this money [source: Bell].
Tip income isn't limited to restaurant and bar workers, either. Other people who work for tips include:
By the way, service charges (that 18 percent gratuity sometimes added to a restaurant check) are not treated as tip income. However, they are treated as wage income, so you'll have to pay taxes on those, too. Your employer will likely take care of that on your paycheck and W-2.
The most important thing to remember when reporting tip income is recordkeeping. Keeping accurate records of your tips helps your employer withhold the correct amount of taxes from your paycheck, and allows you to report the correct amount when filing your taxes [source: IRS]. Some employers require you report your tips at the end of your shift. Some require you report on the 10th of each month. Either way, you should keep a record of your tips each day. You can use a notebook, a spreadsheet, or even a smartphone app designed specifically for tracking your tips.
Now that you have a little background, keep reading to learn how to report your tip income to the IRS come tax time.
Reporting Your Tips on Your Taxes
The IRS provides Form 4070A to keep a record of your tips. You can use other ways to record your tips, but this form is an official way to do it. You don't have to file this form with your employer or the IRS, but if the IRS ever audits you, it's excellent documentation for your case.
So why is reporting your tip income so important? There are a few reasons [source: IRS]:
- Your employer needs to withhold federal income tax, Medicare, and Social Security
- Your employer pays the correct amount into Social Security, which affects your payout in later years
- You want to avoid the penalty for not reporting income (up to 50 percent of the taxes you owe on the unreported tips, as well as potential tax fraud)
Once you've added up your tips for the month (assuming they're over $20), report them [source: Bell]. Your employer then deducts the taxes due from those tips from your regular wages. Since people who make tips usually have a very low salary, sometimes your paychecks might not be enough to cover both regular withholdings and tip withholdings. If this happens, the withholding will carry over to the next pay period. Or, you can make cash payments to your employer to take care of the taxes on your tip income.
Some employers allocate tips, meaning you pay taxes on tips on 8 percent of your employer's monthly sales. You also report these numbers on your tax return, unless you have records proving you earned less [source: Lawyers.com].
Once you receive your Form W-2 from your employer with your earnings, it lists the amount of tips you earned over the past year, if you reported them correctly. Then it's just a matter of filling that number into line 7 of Form 1040. If you didn't report your tips to your employer (or if the amount was under $20 each month), now's the time to report it. File Form 4137, Social Security and Medicare Tax on Unreported Tip Income along with your tax return.
The IRS keeps a sharp eye on unreported tip income, so it's imperative that if tips are part of your wages, you follow the rules. For more information on taxes, check out the links on the next page.
- Bell, Kay. "Don't forget: Tips are taxable income." Bankrate. 2014. (Oct. 4, 2014) http://www.bankrate.com/finance/money-guides/don-t-forget-tips-are-taxable-income-1.aspx
- IRS. "Publication 531 (2013), Reporting Tip Income." IRS.gov. 2014. (Oct. 4, 2014) http://www.irs.gov/publications/p531/index.html
- Lawyers.com. "Taxes When Most of Your Salary Comes from Tips." 2014. (Oct. 4, 2014) http://taxation.lawyers.com/income-tax/taxes-when-most-of-your-salary-comes-from-tips.html
- TaxACT. "'Tips' for Tip Income." TaxACT.com. 2014. (Oct. 4, 2014) http://www.taxact.com/tax-information/tax-topics/tips-for-tip-income.asp