Do I Have to Claim Tips on My Taxes?

All tips received by individuals in the United States constitute taxable income. These earnings are subject to federal income tax, along with Social Security tax and Medicare tax, which are collectively known as FICA taxes. Employees have a legal obligation to accurately report all tip income for tax purposes.

Understanding Taxable Tips

A taxable tip is an amount freely given by a customer to an employee, indicating approval or gratitude for service. This payment is distinct from a service charge, which an employer may add to a customer’s bill, as service charges are considered wages rather than tips for tax purposes. Tips can be received directly from customers, such as cash left on a table or handed to an employee.

Tips also include amounts received through electronic payment methods, such as credit or debit cards, which are then distributed to the employee by the employer. Non-cash tips, such as tickets, passes, or other goods, are also considered taxable income based on their fair market value. Even tips received as part of a tip-sharing or tip-pooling arrangement from other employees count as taxable income for the recipient.

Reporting Tips to Your Employer

Employees have a specific obligation to report their tips to their employer monthly. If an employee receives $20 or more in tips in any given month from a single job, they must report all tips received for that month to their employer. This reporting ensures that the employer can accurately withhold the necessary federal income tax, Social Security tax, and Medicare tax from the employee’s pay.

Tips must be reported to the employer by the tenth day of the month following the month in which the tips were received. This can be done using IRS Form 4070, “Employee’s Report of Tips to Employer,” or through an equivalent system provided by the employer. Consistent and timely reporting allows the employer to meet their tax responsibilities and accurately report the employee’s income to the Internal Revenue Service (IRS).

How Employers Handle Tips

Once employees report their tips, employers assume several tax responsibilities. Employers use the reported tip information to calculate and withhold federal income tax, Social Security tax, and Medicare tax from the employee’s regular wages or other available funds. The reported tips are then included with the employee’s regular wages in Box 1, “Wages, tips, other compensation,” and also in Box 7, “Social Security tips,” of their annual Form W-2, “Wage and Tax Statement.”

Employers also have a matching FICA tax obligation on all reported tips. They must pay their share of Social Security and Medicare taxes on the reported tip income, similar to how they pay these taxes on regular wages. If the total reported tips are less than 8% of the gross receipts, the employer might allocate additional tips to employees. These allocated tips are reported on Form W-2, Box 8, and are subject to income tax but not FICA taxes by the employer.

Reporting Tips on Your Income Tax Return

When preparing an annual income tax return, reported tips are included in the total wages shown on your Form W-2. Tips reported to your employer will appear in Box 1, “Wages, tips, other compensation,” and also in Box 7, “Social Security tips,” on your Form W-2. This information is then directly transferred to the appropriate lines on your Form 1040, “U.S. Individual Income Tax Return,” when filing.

If an employee failed to report tips of $20 or more in a month to their employer, or if the employer could not collect all FICA taxes on reported tips from the employee’s wages, the employee remains responsible for these taxes. In such cases, the employee must report these unreported tips and pay their share of Social Security and Medicare taxes directly to the IRS. This is accomplished by completing and attaching Form 4137, “Social Security and Medicare Tax on Unreported Tip Income,” to their Form 1040.

Any uncollected Social Security and Medicare taxes on reported tips will be identified on Form W-2 in Box 12 with codes A and B. These amounts also need to be accounted for on Form 1040 by adding them to the total tax liability. Properly addressing both reported and unreported tip income ensures full compliance with federal tax regulations.

Keeping Records for Tips

Employees should maintain accurate records of all tips received. This record-keeping helps with accurately reporting tips to your employer each month and correctly preparing your annual income tax return. Records also provide a reliable defense in the event of an IRS audit, demonstrating compliance with tax obligations.

Employees can use various methods to track their tips, such as keeping a daily tip log, utilizing the format suggested in IRS Publication 531, “Reporting Tip Income,” or using a notebook or a mobile application. Each entry should include the date the tips were received and the total amount of tips for that day. Also record the employer’s name and your own name.