How a Paycheck Stub Shows Cash Tips and What It Means for Taxes
Understand how cash tips are reported on a paycheck stub, their impact on taxes, and what they mean for earnings, withholding, and deductions.
Paycheck stubs provide a breakdown of earnings, deductions, and taxes, but employees who receive cash tips may be unsure how these amounts are recorded. Since tipped income is taxable, understanding how it appears on a pay stub is crucial for accurate tax reporting and compliance with labor laws.
Even though cash tips are received directly from customers, they must be reported to employers and the IRS. This affects paycheck calculations, including tax withholding and Social Security contributions.
How Cash Tips Appear on a Pay Stub
Employers record cash tips on a paycheck stub based on the amounts employees report. These tips are typically listed as “Reported Tips” or “Cash Tips” under earnings. Though employees receive this money directly from customers, it is still taxable and factored into total earnings.
Once reported, cash tips are added to gross wages, increasing taxable income. Employers use these amounts to calculate Social Security and Medicare contributions, ensuring compliance with IRS regulations. Some payroll systems also display year-to-date (YTD) totals for cash tips, helping employees track their reported income, which later appears on their W-2.
Distinguishing Reported vs. Allocated Tips
Employees may see reported tips and allocated tips on their paycheck stubs. Reported tips reflect actual amounts disclosed to the employer and are included in taxable wages.
Allocated tips apply in large food or beverage establishments where tipping is customary. If total reported tips fall below 8% of the business’s gross receipts, employers must assign additional tip income to employees to meet IRS requirements. This allocation is based on hours worked or sales generated.
Unlike reported tips, allocated tips do not immediately affect paycheck calculations. They are recorded separately on Form W-2 in Box 8 and are not included in taxable wages unless the employee voluntarily reports them. However, employees must still pay taxes on allocated tips if they actually received more than they reported. Underreporting can lead to audits and penalties.
Tax Withholding Calculations
The IRS requires employers to withhold federal income tax, Social Security tax, and Medicare tax on total taxable earnings, including hourly wages and reported tips. The withholding calculation follows the same structure as regular wages, using the employee’s federal income tax withholding rate based on their Form W-4 elections.
Since tip income varies, withholding amounts fluctuate from one pay period to another. Employers typically combine taxable wages and reported tips before applying the withholding rate, sometimes resulting in higher tax deductions. If wages are insufficient to cover required withholdings, the IRS allows employers to carry over the unpaid tax to future paychecks. Employees are responsible for ensuring their total tax liability is met, which may require making estimated tax payments.
Wages and Tip Credits
Employers in tipped industries often use a tip credit to meet minimum wage requirements while reducing payroll costs. Under the Fair Labor Standards Act (FLSA), federal law allows employers to pay tipped employees as little as $2.13 per hour, provided tips bring total earnings to at least $7.25 per hour. If tips do not meet this threshold, the employer must cover the difference. Some states have stricter requirements, mandating higher base wages or prohibiting tip credits entirely.
To claim the tip credit, employers must inform employees and ensure tips received meet the legal wage threshold. Failure to comply can result in back pay liabilities and penalties. Tip pooling arrangements, where employees share tips, must also follow federal and state guidelines. Noncompliance can lead to lawsuits or Department of Labor investigations.
Social Security and Medicare Deductions
Tip income is subject to payroll taxes, meaning Social Security and Medicare deductions apply to both hourly wages and reported tips. The Federal Insurance Contributions Act (FICA) requires employees to contribute 6.2% of earnings to Social Security and 1.45% to Medicare, with employers matching these amounts. Employees earning over $200,000 annually also incur an additional 0.9% Medicare surtax, though this threshold is rarely met by tipped workers.
Employers are responsible for withholding these amounts from paychecks. If reported tips do not generate enough wages to cover required deductions, the shortfall remains the employee’s responsibility. The IRS expects employees to make up any unpaid FICA taxes when filing their annual tax return. Some employees set aside funds throughout the year or make estimated tax payments to avoid unexpected liabilities.
Determining Net Earnings from Tips
To determine net earnings from tips, employees can review their paycheck stub. Gross earnings include base wages and reported tips, but after subtracting federal and state income taxes, Social Security, and Medicare contributions, the take-home amount may be lower than expected. Voluntary deductions such as health insurance premiums or retirement contributions further reduce net pay.
For employees who rely heavily on tips, tracking total earnings throughout the year is important for budgeting and tax planning. Since tips are taxable, they can affect eligibility for tax credits, deductions, and government benefits. Underreporting can lead to IRS audits, while overreporting without documentation may result in paying more taxes than necessary. Keeping accurate records of daily tip amounts, whether through employer-provided tracking systems or personal logs, helps ensure compliance and financial stability.