If you work in an occupation where tips are part of your total compensation, you need to be aware of several facts relating to your federal income taxes:
- Tips are taxable – Tips are subject to federal income, Social Security and Medicare taxes. The value of non–cash tips, such as tickets, passes or other items of value, is also income and subject to tax.
- Include tips on your tax return – You must include in gross income all cash tips received directly from customers, tips added to credit cards, and your share of any tips received under a tip–splitting arrangement with fellow employees.
- Tip-splitting and cover charges – Tips given to others under the “splitting” arrangement are not subject to the reporting requirement by the employee who initially receives them. That employee should report to the employer only the net tips received. Service (cover) charges, which are arbitrarily added by the business establishment, are excluded from the tip reporting requirements. The employer should add the employee’s share of service charges to the employee’s wages.
- Report tips to your employer – If you receive $20 or more in tips in any one month, you should report all of your tips to your employer. Your employer is required to withhold federal income, Social Security and Medicare taxes. If the tips received are less than $20 in any one month, they need not be reported to the employer. However, those tips are still taxable and must be reported on your tax return and subject to both income and Social Security taxes.
- Employer allocation of tips – Tip allocation is applicable to “large food and beverage establishments” (i.e., food service businesses where tipping is customary and have ten or more employees). These establishments must allocate a portion of their gross receipts as tip income to those employees who “underreport”. Underreporting occurs if an employee reports tips which are less than 8% of the employee’s applicable share of the employer’s gross sale. The employer must allocate to those underreported employees the difference between what the employee reported and the 8%. The allocation amount is noted on the employee’s W-2 but does not have to be reported as additional income if the employee has adequate records to show that the amount is incorrect. Note that the allocated tips are not included in the total wages shown on the employees’ W-2. The IRS frequently issues inquiries where the taxpayer’s W-2 showed an allocation of tips and a lesser amount is reported on the tax return.
- Keep a running daily log of tip income – Tips are a frequently audited item and it is good practice to keep a daily log of your tips. The IRS provides a log in their Publication 1244 [http://www.irs.gov/pub/irs-pdf/p1244.pdf], which includes an Employee’s Daily Record of Tips and Report to Employer to record your tip income.
If you are receiving tips and have any questions, please give this office a call.