Reporting holiday and year-round taxable tip income
Tuesday, December 13, 2022
The season of giving goes beyond presents for family and friends or donations to charities.
December is also when many people who work in restaurants, salons, hotels, and similar industries get their largest tips of the year.
One thing that's the same, however, is the tax consequences of those gratuities.
Regardless of their size or when you get them, tips are taxable income that must be reported on federal and, for most folks, state tax returns.
Workers who've held long-time jobs where tips are commonplace know this. But with the economic changes wrought by the COVID-19 pandemic, notably many people taking gig jobs where tips are part of the compensation equation, it's worth a quick refresher on tips and taxes.
The origin of tips: You've probably heard that the word tip is an acronym of a payment made "to insure prompt service." But how can that be? That would require you to tip beforehand, and tips are left (or not) after a service is completed.
The Oxford English Dictionary says tip originated as a slang word used by criminals more than 400 years ago. The reference book provides historical examples, starting with an example from 1610, and then moving forward 200+ years to a case where a tip could be seen as a bribe. So, OK, maybe that acronym thing did sort of apply.
What determines a tip: Nowadays, however, tips are presented after the fact as a monetary reward for service usually well done.
The Internal Revenue Service says there are four factors that determine whether a payment qualifies as a tip.
- The customer makes the payment free from compulsion.
- The customer must have the unrestricted right to determine the amount.
- The payment should not be the subject of negotiations or dictated by employer policy.
- Generally, the customer has the right to determine who receives the payment.
Normally, all four must apply.
Types of tips: The most common type of tip is added cash.
It can be actual currency left with the restaurant check or handed to the vehicle valet.
Or it can be an amount added when payment for the main service is charged to a credit or debit card. In this case, these electronically paid tips are distributed to employees by the employer who processes the payment.
A third cash tip type is the remuneration received from other employees under any tip-sharing arrangement.
All of these cash tips must be reported by the recipients to their employers. More on this in a minute.
Then there are noncash tips. These can be things such as tickets to sporting or entertainment events, passes, or other goods or commodities that a customer gives the employee.
If you get a noncash tip, you aren't required to report it to your employer.
Direct and indirect tips: This delineation is self-explanatory.
A direct tip is when an employee receives it directly from a customer, even if it is part of a tip pool. Examples of directly-tipped employees include waiters, waitresses, bartenders, and hairstylists.
An indirect tip occurs when an employee, who normally does not receive tips directly from customers, receives a tip. Examples of indirectly-tipped employees include bussers, service bartenders, cooks, and salon shampooers.
Keeping track of, and reporting, your tips: If you're a Don't Mess With Taxes reader who checks out the monthly tax tasks over in the right column, you're familiar with the requirement on the 10th of each month (or the next business day if the 10th falls on a weekend or holiday) that cash tips totaling more than $20 in the prior month be reported to employers.
You can give the information to your boss in any written form you wish as long as it includes your name, address, and Social Security number; your employer's name and address, or establishment name if it's different; the month or time period your tip report covers; and, of course, the amount of your tips. Also, be sure to sign it.
The best way to ensure you meet the monthly reporting deadline is to keep a daily record of your cash tips they receive. The IRS recommends using Form 4070A, Employee's Daily Record of Tips, which is included in IRS Publication 1244, to track the amounts.
It's also a good idea to keep a record of your noncash tips, too. This would be noting the date and value of those noncash gratuities. Why? Because even though you don't have to report them to your employer, you must report their value as income on your tax return.
Also, if you didn't meet the $20+ cash tip threshold to require reporting to your boss, you're not off of Uncle Sam's hook. Those unreported amounts also still are taxable.
Your tips and tax return: Tips reported by employees to their employers are included on the workers' Form W-2 that will be used to complete the tax year's income.
Any tips that weren't reported to an employer must be reported separately on Form 4137, Social Security and Medicare Tax on Unreported Tip Income (excerpt below), which will be added as additional wages on your tax return.
As the Form 4137 title indicates, you also must pay the employee share of Social Security and Medicare tax owed on those tips.
You can find more on tips on tips and taxes at the IRS.gov page Tip Recordkeeping & Reporting, in Tax Topic 761: Tips – Withholding and Reporting, and in IRS Publication 531, Reporting Tip Income.
You also might find these blog items of interest:
- Atypical tips and taxes
- Tip income trips up Yankees' traveling secretary
- Restaurant tips rule change could short-change wait staff
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