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REPORTING TIPS AS TAXABLE INCOME

Gregory S. DuPont July 2, 2019

Those employed in industries in which tipping is common may not know that the IRS views tips as potentially taxable income. Regardless of whether you are a restaurant server, a hairdresser, or a cab driver, all tips you receive, including non-cash gifts, are income and are subject to Federal income tax.

The IRS requires all workers who receive tips to include in their gross income all tips received directly from customers, charged tips paid to their employer, and their share of any tips received under a tip-splitting or tip-pooling arrangement. In addition, the value of non-cash tips, such as event tickets or movie passes, are also considered taxable income.

If you work in a profession in which tips comprise a portion of your income, you are required to keep a daily record of your tips. You can maintain your own tip diary or log, or use IRS Form 4070A, “Employee’s Daily Record of Tips.” The log should track all cash tips collected directly, as well as amounts received from your employer for credit and debit card tips and through any tip-sharing arrangement between co-workers. If you are responsible for distributing pooled tips to co-workers, record the names of each employee and the amount received in your daily log. If your employer has an electronic system for tracking tips, print out and keep a copy of your personal tip record. Whenever possible, keep copies of documents that show your tips, such as restaurant bills and credit card receipts.

Besides keeping your own tip record, you are required by the IRS to report the total amount of tips you have received each month (provided the amount is more than $20) by the 10th day of the following month, or the next business day if the 10th day falls on a weekend or holiday. You do not have to report to your employer non-cash tips or amounts paid out to co-workers through tip-pooling arrangements. However, you are required to report all cash tips, tips received from credit and debit cards, and any payments you received from tip-sharing arrangements. Your employer will withhold Social Security and Medicare (FICA) taxes, as well as Federal income taxes, from the amount you report. Failure to report tips to your employer as mandated may result in a penalty equal to 50% of the FICA taxes you owe on the unreported tips, in addition to the actual tax liability. If your regular pay is not sufficient to allow your employer to withhold the total taxes owed, you have until the end of the calendar year to give your employer the additional amount needed to cover the liability.

When completing your Federal income tax return, you report your tips with your regular wages on line 1 of Form 1040EZ, or line 7 of Form 1040A or Form 1040. You must report all tips, adding the value of non-cash tips to the amounts reported to your employer. The total amount of wages and tips reported to your employer will be shown in box 1 of your Form W-2.

You may also work for an employer that reports allocated tips, which, if applicable, would appear as an amount in box 8 of your Form W-2. A restaurant owner may, for example, use allocation if there is reason to suspect that some staff members are underreporting tips. Generally, tips are allocated by taking a percentage of the restaurant’s overall food and drink sales—usually 8% or an approved lower rate—and subtracting from that total all the tips reported for a given period. Any remaining amount is then allocated to individual employees for tax purposes. However, you can avoid reporting these allocated tips as income by keeping a detailed daily record of your tips, or by demonstrating that the value of the tips you received was higher than the combined total of the amounts shown in your employer’s record of your tips and the amount allocated to you by your employer.

To help service industry employers and employees better comply with tip reporting requirements, the IRS invites businesses to participate in its Tip Rate Determination and Education Program. There are a number of ways for businesses to participate, including the Tip Reporting Alternative Commitment (TRAC) program. By signing up for TRAC, employers agree to educate their employees about their tip reporting obligations and to establish systems for creating and maintaining tip records that can be easily accessed by the IRS. Participation in TRAC limits a business’s liability for unpaid FICA taxes if an “employer-only” audit shows that individual employees have not been reporting their tip income properly.

If you receive tips as part of your income, consult your tax professional for more information.