Anyone who collects cash tips must include them in their taxable income. This requirement is not limited to waiters and waitresses. It applies to anyone who collects tips period. This includes taxicab drivers, beauticians, porters, concierges, etc.
Tips are amounts freely given by a customer to a person who provides a service. They are generally given as cash. They include tips made on a credit or debit card or as part of a tip-sharing arrangement. Tips can be in the form of non-traditional gifts too. These might be tickets to events, wine and other items of value. If you receive $20 or more in tips in any month, you should report all of your tips to your employer. Here are some exceptions:
Tips you give to others under a tip-splitting arrangement are not subject to the reporting requirement by you as the employee initially receiving them. You should report to your employer only the net tips you received.
Service or Cover Charges
These are charges randomly added by the your employer or business establishment. For example, a specific percentage of the bill for parties exceeding X in number. This would be excluded from the tip-reporting requirements. If your employer collects service charges from customers, your share of these charges, as determined by your employer, is taxable to you. These should already be included as part of your wages.
Keep a Running Daily Log of Cash Tip income
Tips are a frequently audited item. It is a good practice to keep a daily log of your tips. The IRS provides a log in Publication 1244. That includes an Employee’s Daily Record of Tips and a Report to Employer for recording your tip income.
Report Tips to Your Employer
If you receive $20 or more in tips in any month, you should report all of your tips to your employer. Your employer is required to withhold federal income, Social Security, and Medicare taxes. If the cash tips received are less than $20 in any month, don’t think you are off the hook. While they don’t need to be reported to the employer, these tips are still taxable. They must be reported on your tax return, as they are subject to income, Medicare and Social Security taxes.
Employer Allocation of Tips
If you work for a large restaurant, you may find when you get your W-2 form that you got tips you didn’t know about. Great! How does that work? Restaurants with a large serving staff report a total called “allocated tips” to the IRS. Here is what allocated tips are all about:
Tip allocation applies to “large food and beverage establishments.” These are food service businesses where tipping is customary. Usually, they have 10 or more employees. These establishments must allocate a portion of their gross receipts as tip income to those employees who “underreport.” Yup, you read that correctly, underreport is one word. This happens if an employee reports tips that are less than 8% of the employee’s share of the employer’s gross sales. The employer must assign to those underreported employees the difference between what the employee reported and the 8% amount.
If this situation applies to you, the allocation amount will be noted in a separate box on your W-2. These allocated tips won’t be included in the total wages shown on your W-2 form. You will need to report the allocated tip amount as additional income on your tax return. The only way you can get out of doing that is if you have adequate records to show that the amount is incorrect. The IRS often questions where the taxpayer’s W-2 shows an allocation of tips and when a lesser amount is reported on the tax return.
Self-Employed Individuals Earning Cash Tips
If you are self-employed, you don’t have an employer to report tips to. So what do you do? You simply include the tips you’ve received in your self-employed income on your tax return for the year you received the tips.
Cash Tips Are An IRS Audit Item
Because they are usually paid in cash, tips are often an audit item. If you receive tips and missed the IRS deadline for reporting those tips to your employer, or if you have any questions, please give Alex Franch, BS EA a call at 781.849.7200. Alex is an enrolled agent with the IRS. He can guide you through the details of what is involved with cash tips. He will help you with any income reporting concerns you may have. Alex will make sure it is all reported right! Remember the sooner you do this, the better off you will be.