DEFINITION of Tip Income

Many providers of services—waiters, hair stylists, taxi drivers and hotel workers—rely heavily on tip income because those types of jobs typically pay minimum wage.

BREAKING DOWN Tip Income

Whether someone leaves money, a gift card, movie passes, etc., tip income is considered income and subject to federal and state taxes. Plus, it doesn’t matter if a tip goes directly to one person or into a tip jar and split among co-workers, it will still need to be claimed as income on your taxes.

The U.S. Department of Labor considers a person who regularly receives more than $30 a month in tips as a tipped employee. The easiest way to keep track is by keeping a log and reporting tips to your employer. You must fill out Form 4070—Employee’s Report of Tips to Employer—or something similar. This is due on the 10th day of the following month for tips received in the previous one. Monthly tips under $20 total do not need to be claimed.

The report must be signed by the employee and contain the name, address and social security number; the month or period it covers and the total tips received.

Employers and Tip Income

Employers are also required to comply with federal requirements with respect to tips received by all employees. They must collect income tax, social security tax and Medicare tax on all tips. The total tip income reported by employees in any month must equal a minimum of 8 percent of the employer’s total receipts over the period.

Tipped employees basically work on the honor system. They’re supposed to report all tips, but that’s not always the case. Employers are charged with many responsibilities in addition to following federal regulations.

The IRS lists the following tip tasks for employers on its website:

  • Educating and training all employees on proper reporting methods for tips.
  • Gathering tip reports from each employee at least once per month.
  • Paying FICA and state income taxes on employee tipped income.
  • Filing IRS Form 8027 if your restaurant regularly accepts tips and employs more than 10 workers.
  • Applying for the FICA Tip Tax Credit on IRS Form 8846 if desired.
  • Ensuring that tip reporting for all employees meets the federal minimum threshold of 8 percent of gross receipts.
  • Verifying the accuracy of the reports with any employee who does not meet the minimum threshold and applying for a special exception with the IRS.

Some businesses, such as restaurants, assume that employees will earn tips and will thus provide a lower hourly wage rate. If an individual collects tips over a given amount during a calendar month, it must be reported to the employer and to the government, since taxes have not been withheld like they are for normal income.