Apr 3 2014, 10:40pm CDT | by Forbes
All tips you receive – whether by cash, included on a credit card or as part of a tip-sharing arrangement – are reportable as income and are subject to federal income tax. For tax purposes, tips also include items which are not as traditional as cash, including tickets or other items of value.
To report your tips, you need to keep good records. One of the best records to keep is a tip diary, or a daily tip record. To keep a tip diary, you can use federal form 4070A, Employee’s Daily Record of Tips (downloads as a pdf). You can also just use a regular old notebook: each workday, write the date and the amount of tips you are paid directly; tips from credit and debit card charges paid out by your employer; the amount you receive as part of a tip splitting agreement; and the value of any noncash tips.
Don’t forget that the IRS now treats service charges or “autocrats” as wages rather than tips. As a result, you would not include service charges in your tip diary.
Keep your tip diary for as long as you keep your tax records (for most taxpayers, that is three years after the date of filing or April 15, whichever is later).
In most cases, you will also want to report cash, check, and debit and credit card tips to your employer. This helps your employer make the proper federal withholding for taxes (as well as state and local, where appropriate); it also means that taxes are properly withheld for Social Security and Medicare purposes. You do not report the value of any noncash tips to your employer since you don’t pay Social Security or Medicare on these tips.
Assuming that your employer doesn’t have an alternate reporting system, use federal form 4070, Employee’s Report of Tips to Employer (downloads as pdf). If you don’t have an alternate reporting system or use form 4070, you can simply give your employer a statement each month with your name, address, and Social Security number; your employer’s name and address; the month you received tips; and your total tips. You must sign and date the statement and give it to your employer by the 10th day of the following month; be sure to keep a copy with your tax records.
If you do not report tips to your employer as required, you may be subject to a pretty substantial penalty in addition to the taxes you owe.
You’ll report all tips (cash and non cash) you receive on your federal income tax return (line 7 of your form 1040 or 1040-A). Any tips that you reported to your employer – as well as service charges reported by your employer – will show up on your form W-2. You’ll report your form W-2 on your own return as well as any overages on your own (those might be subject to Social Security number and Medicare taxes).
In some circumstances, your employer will allocate tips to you. Those will be reported in box 8 of your Form W-2 (not in box 1). No federal income taxes or Social Security and Medicare are withheld on allocated tips.
No matter whether you report or your employer reports, make sure you include all tip income.
And don’t be tempted to cheat: the IRS is pretty savvy. Some restaurants have tip agreements with the IRS where tip income is estimated to be a certain percentage of receipts. In other instances, the IRS relies on formulas based on the type of restaurant, market and day and time of service. Remember, the industry standard for tips is around 15%: reporting less than that percentage in the absence of documentation to back you up can be dangerous (remember that tip journal!).
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