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Working for tips is hard enough, but the tax rules for tips can make life even harder if you don’t know what to do. Most tax software can help you report your tips. Here are the basics.
Are tips taxable?
Tips are taxable, including cash tips. Report all of your tips to your employer each month if they total $20 or more. Use IRS Form 4070. Report last month's tips to your employer by the 10th of the current month.
Do you have to report cash tips to the IRS?
Tips are taxable and count as income. Tips can include cash that customers leave, tips that customers add to debit or credit card charges, distributed tips from your employer and tips shared by other employees.
Service charges, which are fees automatically added to a customer’s bill, technically aren’t tips; the IRS considers them regular wages. That means you’ll probably see them on payday rather than at the end of each shift. Examples of service charges include:
Bottle service charges.
Room service charges.
A gratuity automatically added for large parties.
Keep careful records
Keep track of tips you get in cash and via credit or debit card for each day you work.
If you have to share or pool your tips, keep daily records of what you actually net. For example, if you get $100 in tips but have to give $25 to the bartender and busboy, you'd net $75.
If you don’t have a tracking method of your own, you can use IRS Form 4070A.
Tally and report your tips every month
The IRS requires you to report your tips monthly to your employer if they total more than $20. Use IRS Form 4070 to do that. You’ll need to turn it in by the 10th of the month after you receive the tips. For example, if you made $100 in tips in January, you'd need to report those by Feb. 10. If the 10th falls on a weekend or a holiday, you can do it the next business day.
Note: You don’t give the form to the IRS, you give it to your employer, which uses it to calculate how much payroll tax to withhold from your paycheck.
Your employer is allowed to require you to report your tips more than once a month.
Your employer is allowed to offer an electronic reporting method, so the paper version of Form 4070 is often more of a backstop.
Know how the math works
Tipped workers typically make money via both a set hourly wage and tips.
Many people get their tips at the end of each shift, but the taxes on those tips don’t surface until the workers report the tips and the employer takes the related payroll taxes out of their paychecks.
As a result, it’s possible that the hourly wages on your paycheck might not cover the taxes you owe on the tips you already took home. If that happens, you can make a tax payment through your employer or have your employer take it out of your next paycheck.
Stay on top of this: If you still have outstanding payroll taxes by the end of the year, the IRS could hit you with a tax penalty for underpayment.
When you file your tax return, report your tips again
At the end of the year, your employer will provide a W-2 form reflecting your wages and the tips you reported; a copy goes to the IRS. You use the W-2 to file your tax return.
Remember, when you file your Form 1040, you need to report all of your tips — even the ones from months when the total was less than $20.
What happens if I don’t report my tips?
It may be tempting to avoid the monthly hassle and not report your tips, but that could be a huge mistake.
Tips on credit and debit cards leave a paper trail, for one thing. That could come back to haunt you if you're audited.
When you don’t report your tips, the Social Security Administration doesn’t know you earned the money, which can affect the size of your benefits when you retire.
How to catch up on unreported tips
If you don’t report your tips during the year and then decide you want to come clean on your tax return, Form 4137 will help. It lets you report overlooked tips and pay your fair share when you file your taxes. However, you could be on the hook for a big penalty: 50% of the Social Security and Medicare taxes you owe, in addition to those taxes.
If that’s the case, Form 4137 has a tip of its own: “You can avoid this penalty if you can show (in a statement attached to your return) that your failure to report tips to your employer was due to reasonable cause and not due to willful neglect.”