When to Use Tax Form 4137: Tax on Unreported Tip Income

If you work in an industry where it’s customary to receive a portion of your income from customer tips, you still need to pay Social Security and Medicare taxes on those earnings. However, it’s only possible to pay these taxes during the year if you report your tip income to your employer. If you don’t, you may need to use IRS Form 4137 to calculate the additional tax you owe on the unreported tip income.

Taxpayers who regularly receive tips at work also receive hourly wages from their employers. Your employer will withhold income, Social Security and Medicare taxes from your wages, but calculates the amount to withhold based on your total earnings, which includes your tip income — not just wages. However, if your tip income is substantial, the wages your employer pays you may be insufficient to cover your taxes, and it may be necessary to give them a portion of your tips to pay the difference.

Any month you earn $20 or more of tips, you have an obligation to report them to your employer so they can calculate the appropriate amount of tax withholding; otherwise, the IRS can increase the amount you owe with a tax penalty.

However, failing to report all tip income doesn’t excuse you from reporting it on your tax return. In this case, not only must you pay income tax on these earnings, you also need to calculate the Social Security and Medicare taxes you owe using Form 4137.

When you receive a W-2 from your employer, it reports your hourly wages and the tips you actually report, or sometimes, tips that have been allocated to you – see below. At the end of the year, the difference between the amounts reported in box 1 of your W-2 and the income you actually earn when including your unreported tips is the amount you need to report on Form 4137.

If you fail to report tip income that’s at least 8 percent of your food and drink sales or choose not to participate in your employer’s Attributed Tip Income Program, your employer may allocate tips to you – which they will report in box 8 of your W-2. Unless you have sufficient evidence that your employer’s allocation is inaccurate, you must report this amount as unreported tip income when calculating your Medicare and Social Security tax on Form 4137.

Form 4137 is only one page in length and requires two straightforward calculations. First, you must report all unreported tips -- even if under $20 – which are subject to the Medicare tax. This amount is multiplied by the appropriate tax rate. The second calculation for your Social Security tax is similar, but it only applies to the first $106,800 of income. Therefore, if the amount of your unreported tips plus the income reported on your W-2 exceeds this amount, you don’t have to pay Social Security tax on the excess. The additional tax liability is transferred to your total taxes amount as reported on your tax return.

When you use TurboTax to prepare and file your taxes, we’ll ask simple questions about your tip income and handle all the calculations for you. We’ll complete Form 4137 on your behalf and file it with the IRS.