What Does the IRS Consider to be Tips?
The IRS considers tips to be optional or extra (discretionary) payments given by customers to employees for performing a service.
Any money an employee receives from customers — whether in cash or through a digital/electronic process — is considered a tip. Tips are reported as taxable income to the IRS. In addition, the IRS states that the value of noncash tips, such as scratch-off lottery tickets, gift cards, or coupons, is the actual value of a tip.
In other words, if a waiter receives a $10 gift card from a customer in lieu of a cash tip, the waiter has received a $10 tip according to the IRS.
Tips received from tip splitting, tip pools, or other forms of tip-sharing among employees are also considered tips that must be reported as income to the IRS.
Do You Have to Report Cash Tips to the IRS?
Cash tips, charged tips, and tips received through tip-sharing/tip pools are subject to Medicare and Social Security taxes. Consequently, these tips must be reported to employers.
However, if an employee receives less than $20 in tips during a month, and worked for just one employer during that month, they do not need to report those tips. The IRS does not consider this small amount to be taxable income.
Do You Have to Claim Credit Card Tips on Your Tax Return?
Yes. Tips charged to credit cards must be claimed on your federal tax return, as long as the amount an employee receives in a single month while working for one employer is more than $20.
How and When Do You Report Tips to Your Employer?
The IRS requires an employee to report the monthly amount of all tips to their employer in writing.
Although there is no formal document that employees must use to report their tips to employers, a tips statement should include the following:
- Name and signature of the employee
- Address and social security number of the employee
- Name and address of the employer’s business
- What month the statement covers
- Total amount of tips received for the month
An alternative to a written statement is the Employee’s Report of Tips to Employer (Form 4070). For additional information about logging and reporting tips to an employer, read IRS Publication 1244.
How Do You Keep a Daily Record of Tips Using IRS Form 4070-A?
The IRS expects employees to keep a daily record of their tips, report cash and electronic tips to their employers, and report tips on their federal income tax returns. Form 4070-A is a voluntary form that makes it easier for employees to maintain accurate records of their daily tips received from debit and credit cards and tip pools. There is also a section for recording monthly tip amounts.
Are Tips Included On a W2?
Employees receiving tips from customers should get a W-2 from their employer that shows the amount of allocated and reported tips. Box 1 on a W-2 is the “Wages, Tips, Other Compensation” where the employee would see their wage and reported tips for that particular tax year.
If tips reported to an employer are less than 8% of that business’s gross sales, the employer must divide the difference among employees. When this happens, the employer must fill out Form 8027. This form is called Employer’s Annual Information Return of Tip Income and Allocated Tips.
What Is IRS Form 4137?
Form 4137 (Social Security and Medicare Tax on Unreported Tip Income) is used to calculate how much Medicare and Social Security tax you owe on tips and allocated tips, if applicable (usually when tips were not reported to an employer).
Filing Form 4137 means the appropriate amount of taxes will be withheld to be reflected on your Social Security wage record when you apply for Social Security payments.
What Happens If You Don’t Report Tips?
If you don’t report tips, the IRS may assess a penalty of 50% of the Social Security and Medicare tax due on cash, electronic, and allocated tips. For example, if a waiter did not report $3,000 in tips to their employee for a period of three years, and the IRS discovers the waiter did not report those tips, that person could owe back taxes.
In this case, the back taxes owed would be the full amount of the SS/Medicare tax plus half of that full amount.
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