What is Tip Income?
Many customer service providers—waiters, hairstylists, taxi drivers and hotel workers—rely heavily on tip income because the jobs typically pay minimum wage. The U.S. Department of Labor (DOL) considers a person who regularly receives more than $30 a month in tips to be a tipped employee.
- Tip income is a large portion of total income for workers in certain industries.
- Tip income is taxable and must be reported to the Internal Revenue Service (IRS).
- Both employers and employees have specific reporting responsibility relating to tip income.
How Tip Income Works
Some businesses, such as restaurants, assume that employees will earn tips; thus, these businesses will provide a lower hourly wage rate. If an individual collects more than $20 in tips during a calendar month, then it must be reported to the employer and to the government, since taxes have not been withheld as they are for regular income at that point.
Tips can come in many forms. Whether someone pays a tip with cash, check, debit card, or credit card, tips are considered income by the Internal Revenue Service (IRS) and are subject to federal and state taxes. It doesn’t matter if a tip goes directly to you or into a tip jar that is split among your co-workers—it will still need to be claimed as income on your taxes.
Tip Income vs. Service Charges
Service charges are not considered tips, as they will be included in your non-tip wages as tracked by your employer. Service charges include large-party charges at a restaurant, bottle service charges, room service charges, contracted luggage service charges, and required delivery charges. Service charges and tip income are subject to both income tax withholding and Federal Insurance Contributions Act (FICA) withholding for Social Security and Medicare.
Are Tips Taxable?
Yes, tips are taxable. You have a responsibility to track and report tip income to your employer. You also have to report your tips on your income tax return and pay taxes on it. Additionally, your employer is responsible for withholding your taxes and reporting your tip income to the IRS.
As a tipped employee, you are tasked with keeping a daily tip log and reporting tips to your employer on a monthly basis. Employees can use a Form 4070A—Employee’s Daily Record of Tips— to keep track of tip income. This exact form is not necessary, but it is prudent to use it or something similar.
Employees should fill out Form 4070—Employee’s Report of Tips to Employer—to report tip income on a monthly basis to their employer. Again, this exact form is not required, but the same information must be included in whatever format is required by the employer. The report must be signed by the employee and contain the employee’s name, address, and Social Security number. Additionally, it must include the month or period covered and the total tips received.
This report is due on the 10th day of the month for all tips received in the previous month. Monthly tips under $20 total do not need to be reported to your employer, but they still should be claimed on your tax return and included in your taxable income.
Employers are also required to comply with federal requirements with respect to tips received by all employees. They must collect and pay 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% of the employer’s total receipts over the period.
If your regular pay in your paycheck is insufficient to cover all your tax withholdings on your regular pay plus your tipped income, then you will have to pay your employer money to cover the rest of the taxes. You can pay this money up until the close of the calendar year.
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 and federal 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% of gross receipts.
- Verifying the accuracy of reports for any employee who does not meet the minimum threshold and applying for a special exception with the IRS.