How Much Are Credit Card Tips Taxed?

Tips received through credit card transactions are subject to taxation. The Internal Revenue Service (IRS) considers these amounts as income, regardless of whether they are received directly in cash or processed electronically. This article explains the tax implications and reporting requirements for credit card tips for both employees and employers.

Tips as Taxable Income

Tips are considered taxable income by the IRS. This means that the money received as a tip is treated as a form of wages and is subject to federal income tax, Social Security tax, and Medicare tax. The taxation applies whether the tip is given directly to an individual or is part of a tip-pooling arrangement.

A tip is defined as an amount a customer voluntarily pays an employee. This distinguishes it from a service charge, which is an automatic fee added to a bill by the establishment. Service charges are not considered tips and are instead treated as regular wages by the employer.

Taxes Applied to Credit Card Tips

Credit card tips are subject to several federal taxes, similar to regular wages earned by an employee. These include federal income tax, Social Security tax, and Medicare tax.

Social Security tax, part of the Federal Insurance Contributions Act (FICA), applies to reported tips. The employee’s share of Social Security tax is 6.2% of wages up to an annual limit, which was $168,600 for the 2024 tax year. Employers also pay an equal 6.2% share.

Medicare tax, also a part of FICA, is applied to all reported tips without any income limit. The employee’s share of Medicare tax is 1.45% of all wages and tips. Employers also pay an equal 1.45% share.

An additional Medicare tax of 0.9% applies to individual earnings exceeding certain thresholds: $200,000 for single filers, heads of household, and qualifying widow(er)s; $250,000 for married couples filing jointly; and $125,000 for married individuals filing separately. This additional tax is only the employee’s responsibility; employers do not match this portion. These taxes are withheld from an employee’s regular wages, especially if the tips themselves are insufficient to cover the tax liability.

Employee Reporting of Credit Card Tips

Employees are responsible for reporting all tips received, including those from credit card transactions, to their employer. Tips totaling $20 or more received in a calendar month from a single employer must be reported. Non-cash tips, however, do not need to be reported to the employer, though they are still considered taxable income.

The reporting should occur by the 10th day of the month following the month in which the tips were received. If the 10th falls on a weekend or holiday, the deadline shifts to the next business day. Employees can use IRS Form 4070, “Employee’s Report of Tips to Employer,” or an employer-provided system to submit this information.

Keeping a daily record of tips, perhaps using IRS Form 4070A, “Employee’s Daily Record of Tips,” helps ensure accurate reporting. This record should include cash tips, credit/debit card tips, and any amounts received from tip-sharing arrangements.

Employer Responsibilities for Credit Card Tips

Employers have responsibilities regarding credit card tips. Employers must withhold federal income tax, Social Security tax, and Medicare tax from the employee’s total wages, including reported tips. If the tips themselves are not enough to cover the tax liability, the employer will withhold the remaining taxes from the employee’s regular wages.

Employers are required to remit these withheld taxes to the IRS on behalf of their employees. They also report the total tip income and withheld taxes on the employee’s Form W-2, “Wage and Tax Statement,” at the end of the year.

Certain large food or beverage establishments must also file IRS Form 8027, “Employer’s Annual Information Return of Tip Income and Allocated Tips”. This form is required if tipping is customary and the establishment normally employed more than 10 employees on a typical business day in the preceding calendar year. Form 8027 can lead to “allocated tips” if reported tips are less than 8% of gross receipts, though allocated tips are not subject to withholding.