Tip income

06 Dec, 2015 TAX LAW 0

Chapter 6
Tip income

Introduction

Tips are one of the least-reported types of income and the IRS has been trying to do something about that. Since 2000, it has been undertaking a controversial audit program under which it conducts employer-only tip examinations and assessments for FICA in cases of “flagrant violations” of tip reporting rules. This audit program focuses on cases of serious noncompliance at businesses in which tipping is customary. As an alternative to audit examinations, the IRS also established voluntary compliance agreements for industries, such as the restaurant industry, where tipping is customary. These agreements are designed to enhance tax compliance among tipped employees through taxpayer education, instead of through traditional enforcement actions, such as tip examinations. Nevertheless, employee reporting requirements and employer withholding requirements have not changed. This chapter spells out the details of reporting tip income.

This chapter is for employees who receive tips.

All tips you receive are income and are subject to federal income tax. You must include in gross income all tips you receive directly, charged tips paid to you by your employer, and your share of any tips you receive under a tip-splitting or tip-pooling arrangement.

The value of noncash tips, such as tickets, passes, or other items of value, is also income and subject to tax.

Reporting your tip income correctly is not difficult. You must do three things.

Keep a daily tip record.
Report tips to your employer.
Report all your tips on your income tax return.

This chapter will explain these three things and show you what to do on your tax return if you have not done the first two. This chapter will also show you how to treat allocated tips.

For information on special tip programs and agreements, see Publication 531.

Useful Items

You may want to see:

Publication

531 Reporting Tip Income
1244 Employee’s Daily Record of Tips and Report to Employer

Form (and Instructions)

4137 Social Security and Medicare Tax on Unreported Tip Income
4070 Employee’s Report of Tips to Employer

Keeping a Daily Tip Record

Why keep a daily tip record. You must keep a daily tip record so you can:

Report your tips accurately to your employer,
Report your tips accurately on your tax return, and
Prove your tip income if your return is ever questioned.

How to keep a daily tip record. There are two ways to keep a daily tip record. You can either:

Write information about your tips in a tip diary, or
Keep copies of documents that show your tips, such as restaurant bills and credit or debit card charge slips.

You should keep your daily tip record with your tax or other personal records. You must keep your records for as long as they are important for administration of the federal tax law. For information on how long to keep records, see How long to keep records in chapter 1.

If you keep a tip diary, you can use Form 4070A, Employee’s Daily Record of Tips. To get Form 4070A, ask the Internal Revenue Service (IRS) or your employer for Publication 1244. Also, Publication 1244 is available online at www.irs.gov/pub/irs-pdf/p1244.pdf. Publication 1244 includes a 1-year supply of Form 4070A. Each day, write in the information asked for on the form.

In addition to the information asked for on Form 4070A, you also need to keep a record of the date and value of any noncash tips you get, such as tickets, passes, or other items of value. Although you do not report these tips to your employer, you must report them on your tax return.

If you do not use Form 4070A, start your records by writing your name, your employer’s name, and the name of the business (if it is different from your employer’s name). Then, each workday, write the date and the following information.

Cash tips you get directly from customers or from other employees.
Tips from credit and debit card charge customers that your employer pays you.
The value of any noncash tips you get, such as tickets, passes, or other items of value.
The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees to whom you paid the tips.

EXPLANATION

An arbitrary fixed charge that your employer adds to the customer’s bill is not a tip or gratuity subject to tip reporting and withholding requirements. Even if it is called a tip, the amount an employee is guaranteed from his or her employer is additional wage compensation.

Example

A club does not permit its members to tip its employees, but adds 10% to each member’s restaurant charges. This additional amount is set aside in a fund and is disbursed monthly to all employees.

Because the employer controls the allocation of the funds, they are additional wages, not tips.

However, if a headwaiter receives one lump-sum payment to be distributed to all waiters and waitresses, then the payment is income from tips. The headwaiter would include in his income only the amount he retained, not the total he distributed.

Electronic tip record. You can use an electronic system provided by your employer to record your daily tips. If you do, you must receive and keep a paper copy of this record.

Service charges. Do not write in your tip diary the amount of any service charge that your employer adds to a customer’s bill and then pays to you and treats as wages. This is part of your wages, not a tip. See examples below.

Example 1. Good Food Restaurant adds an 18% charge to the bill for parties of 6 or more customers. Jane’s bill for food and beverages for her party of 8 includes an amount on the tip line equal to 18% of the charges for food and beverages, and the total includes this amount. Because Jane did not have an unrestricted right to determine the amount on the “tip line,” the 18% charge is considered a service charge. Do not include the 18% charge in your tip diary. Service charges that are paid to you are considered wages, not tips.

Example 2. Good Food Restaurant also includes sample calculations of tip amounts at the bottom of its bills for food and beverages provided to customers. David’s bill includes a blank “tip line,” with sample tip calculations of 15%, 18%, and 20% of his charges for food and beverages at the bottom of the bill beneath the signature line. Because David is free to enter any amount on the “tip line” or leave it blank, any amount he includes is considered a tip. Be sure to include this amount in your tip diary.

Reporting Tips to Your Employer

Why report tips to your employer. You must report tips to your employer so that:

Your employer can withhold federal income tax and social security, Medicare, Additional Medicare, or railroad retirement taxes,

Your employer can report the correct amount of your earnings to the Social Security Administration or Railroad Retirement Board (which affects your benefits when you retire or if you become disabled, or your family’s benefits if you die), and

You can avoid the penalty for not reporting tips to your employer (explained later).

What tips to report. Report to your employer only cash, check, and debit and credit card tips you receive.

If your total tips for any 1 month from any one job are less than $20, do not report the tips for that month to that employer.

If you participate in a tip-splitting or tip-pooling arrangement, report only the tips you receive and retain. Do not report to your employer any portion of the tips you receive that you pass on to other employees. However, you must report tips you receive from other employees.

Do not report the value of any noncash tips, such as tickets or passes, to your employer. You do not pay social security, Medicare, Additional Medicare or railroad retirement taxes on these tips.

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