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So you just picked up a new gig in a restaurant, hotel, or bar, and you keep all the tips you earn. Are these tips taxable?
The answer is yes, but as with anything in tax, the rules can get complicated.
Here’s what you need to know.
Table of Contents
Are Tips Taxable?
The answer is yes, they are. The IRS defines gross income as “all income you receive in the form of money, goods, property, and services that is not exempt from tax.”
This means that any income you receive is taxable unless there is a specific tax exemption for it, and there is no specific tax exemption for tip income.
Tips Tax Rate
Are tips taxable at the same rate as your hourly wage? Yes, they are.
Unlike for long-term capital gains, there is no special tax rate for tip income.
Although it may “feel” like a different kind of income as your hourly wage, it’s all thrown into the same pot and cooked at the same temperature, that is, taxed at the same rates.
How to Calculate Tips Income
Service Charge vs. Tip
Keep in mind that for income tax purposes, a service charge is not the same thing as a tip.
You should verify this with your employer, but in general, a service charge or other automatic gratuity is treated as regular wages, not tips, for income tax purposes.
Tips vs. Service Charges
In most instances it will be fairly obvious when a payment is a service charge or a tip. But in case you’re not sure, the IRS has given taxpayers some guidance on distinguishing service charges from tips. The absence of any one of the factors below should lead one to believe that a payment is a service charge rather than a tip:
- The payment is completely voluntary. If not, it’s probably a service charge.
- The customer determines the amount of the payment. If this isn’t the case, it’s probably a service charge.
- The payment amount is not dictated by employer policy. If it is, it’s probably a service charge.
- The payment amount is not subject to negotiation. If it is, it’s probably a service charge.
- The customer has the right to determine who receives the payment. If not, it’s probably a service charge.
What About Non-Cash Tips?
Although not common in the food service industry, occasionally a worker will receive a non-cash tips such as tickets, jewelry, or other such goods in lieu of cash.
These non-cash tips are just as taxable as cash tips.
Daily and Monthly Tip Reporting
Before tax season even starts, you have some IRS-instituted duties to take care of on a daily and monthly basis.
These duties are:
- Keeping a daily tip record and
- Reporting tips in excess of $20 monthly to your employer.
Daily Tip Record
Under IRS rules, you should keep a daily record of your tips.
You can use your own spreadsheet or other method of doing this or you could use Form 4070A to keep track of your tips.
Monthly Reporting
If you receive $20 or more in tips for a given month, you must report these tips to your employer by the tenth day of the following month. If the tenth day falls on a weekend or holiday, the deadline is the first business day after the tenth of the month.
If your employer provides you with a form to report your tips, you should use it. If your employer doesn’t have a specific form for reporting tips, you could complete and submit Form 4070 to your employer or submit your own form.
Regardless of how you report your tips to your employer, the following information is required:
- Your name, address, and social security number.
- Your employer’s name and address.
- The month the report covers.
- The total tips reported in that month.
Note that you are not required to report non-cash tips to your employer, but these still must be reported on your tax return.
Reporting Tips on Taxes
Finally, when you file your tax return — assuming that you’ve reported all your tips to your employer — you can just take the amount in Box 1 of your W-2 and plug it into your tax software.
Allocated Tips
Per Treasury Department regulations, if a restaurant’s reported tips are less than 8% of its gross receipts, it must allocate the difference between the actual reported tips and 8% of its gross receipts to the employees who receive tips. So if a restaurant has $1,000,000 in gross receipts and its employees report $70,000 in tips during the year, it must allocate an additional $10,000 in tips among the employees.
These allocated tip amounts are reported to the employees in Box 8 of their Form W-2.
This sounds horrible — having to report more tips than you actually earned and reported to your employer — but here’s the silver lining: if you’ve kept your daily tip records and can prove that you received less tips than the amount allocated by your employer, you can ignore the Box 8 amount. So keep those records!
Unreported Tips
Did you forget — or purposely “put off” — reporting your tips to your employer during the year?
If so, shame on you, but know that you have one more chance to redeem yourself.
It’s called Form 4137, and it’s the form you should fill out and attach to your tax return if you didn’t report all your tips during the year.
Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
