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 below.
- 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