I Wait Tables After School. Are My Tips Taxable?

Tips are an important part of income for many service professionals, and understanding how they are treated for tax purposes is crucial. All tips, whether received in cash, through credit card payments, or in non-cash forms, are considered taxable income by the Internal Revenue Service (IRS). Properly reporting these earnings ensures compliance with tax laws and can impact future benefits.

What Qualifies as Taxable Tip Income

The IRS defines a tip as a discretionary payment made by a customer to an employee. This means the customer freely chooses to give the payment, determines the amount, and there is no compulsion by the employer. Tips are distinct from mandatory service charges, which are considered wages. All cash and non-cash tips are considered income and are subject to federal income taxes. This includes cash received directly from customers, tips received through electronic payments like credit or debit cards, and amounts received from other employees through tip-sharing arrangements.

Tips can also be indirect, such as tip-outs received from other employees, like bussers or bartenders. Even non-cash tips, such as tickets, passes, or other items of value, are considered taxable income, though they are not reported to the employer. All forms of tips are subject to federal income tax, Social Security tax (FICA), and Medicare tax. Maintaining accurate daily records of all tips received, regardless of their amount or form, is important for tax compliance and proper reporting.

Reporting Tips to Your Employer

Employees must report all cash tips totaling $20 or more received in a calendar month to their employer. This ensures the employer can correctly withhold income, Social Security, and Medicare taxes. For personal record-keeping, employees can use IRS Form 4070A, “Employee’s Daily Record of Tips,” to track their daily earnings. While not mandatory, using this form or a similar personal log helps maintain detailed records.

For formal reporting to the employer, employees can use IRS Form 4070, “Employee’s Report of Tips to Employer,” or a similar written statement. This report must include the employee’s name, address, Social Security number, the employer’s name and address, the period the report covers, and the total amount of tips received. Reports are generally due by the 10th day of the month following the month in which the tips were received. Timely and accurate reporting is important for both the employee’s tax obligations and to ensure the employer can properly process payroll and tax withholdings.

How Employers Handle Reported Tips

Once employees report their tips, employers assume responsibilities for tax compliance. Employers collect income tax, Social Security tax, and Medicare tax from the reported tip income. This involves factoring reported tips into the employee’s regular wages for tax withholding. If an employee’s regular wages are insufficient to cover the tax withholding on their reported tips, the employee might need to provide additional funds to the employer or adjust their W-4 form.

Reported tips are included on the employee’s Form W-2, “Wage and Tax Statement,” at the end of the year. They are part of the total wages, tips, and other compensation in Box 1 and are also shown in Box 7 as Social Security tips. Employers also have reporting obligations to the IRS, such as filing Form 941, “Employer’s Quarterly Federal Tax Return,” to report withheld taxes. Large food or beverage establishments may also need to file Form 8027, “Employer’s Annual Information Return of Tip Income and Allocated Tips,” which reports total receipts and tips received by employees, and may include allocated tips if reported tips are below a certain percentage of gross receipts.

Including Tips on Your Annual Tax Return

Tips reported to your employer should be reflected on your Form W-2 in Box 1 and Box 7. This information is used when completing your personal income tax return, Form 1040. All tips, whether reported to an employer or not, must be included as income on your annual tax return.

If you received tips but did not report them to your employer, perhaps because the monthly total was less than $20 or due to an oversight, you must report these amounts directly on IRS Form 4137, “Social Security and Medicare Tax on Unreported Tip Income.” This form calculates the Social Security and Medicare taxes due on those unreported tips. The Social Security and Medicare tax calculated on Form 4137 is then transferred to Schedule 2, “Additional Taxes,” of Form 1040. The income amount is also included in your total income on Form 1040.