If you're a restaurant server, bartender, barista, or other employee who makes tips, you should understand how those tips fit into your taxes.
If you've started working as a food service employee, you might be wondering: Are tips taxable? The simple answer is yes, the IRS treats tips as taxable income. If you earn tips, then you're responsible for paying income, Social Security, and Medicare tax on that tip money.
Let's take a deeper dive into everything you need to know about tips and taxes.
How are tips taxed?
The IRS requires your employer to withhold enough funds from your wages to cover the income, Social Security, and Medicare taxes on both your hourly wages and your tips. But you are responsible for reporting your tips to your employer.
The amount withheld from your paycheck is based on the total of your wages plus the tip income you report, even if you receive the tips directly from the customer in cash. It's important for you to keep an accurate daily record of the tips you received so that you can report that amount to your employer every month.
Why are tips taxable and what is a taxable tip?
Tips are taxed because they are a form of income. Some tips are subject to Social Security and payroll taxes, and some are not. Tips that must be reported and taxed include:
- Cash tips totaling more than $20 in a one-month period
- Electronic tips paid through credit, debit, or gift cards
- Tips received from other employees that are paid to you through tip pools, tip splitting, or other tip-sharing arrangements
Tips that don't need to be reported
If you don't earn at least $20 in tips during the month, you don't have to report the tips to your employer. But you still need to include these tips in taxable income when you prepare your income tax return. If you work at more than one job, apply the $20 limit to each one.
Noncash tips, such as tickets or other valuable items, also don’t need to be reported.
Pooled or shared tips you pay to others
You can reduce the amount of your reportable tips if you share some of them with other employees. For example, if you receive a $125 tip and give the busser and bartender $35, then you only need to report $90 in tips.
Do I need to report "auto-gratuities" or surcharges?
Some employers may add service charges or large party charges to a customer's bill. The IRS doesn't consider these to be tips because the customer didn't choose who to pay or how much to pay. So, you don't need to report these charges as tips to your employer. Your employer will include the amounts you receive from those charges on your paycheck, so you'll be paying income, Social Security, and Medicare taxes on that income already.
What work-related expenses can food service workers deduct from their taxes?
Beginning in 2018, unreimbursed employee expenses are no longer eligible for a tax deduction on your federal tax return unless you are itemizing. But some states continue to provide a deduction on your state tax return if you qualify.
If you don't take the standard deduction but instead choose to itemize, you may be eligible to deduct unreimbursed expenses that exceed 2% of your adjusted gross income. You must have receipts for these expenses in order to deduct them:
- Work uniforms, if they're necessary for employment and you're not able to wear them for everyday use
- Classes, certifications, or licenses
- Tools and supplies you must use for work
- Transportation, meals, entertainment, and lodging needed for your job
Most food service workers are employees and not independent contractors. Generally, if the payer controls what work will be done and how it will be done, then the worker is an employee and not an independent contractor.
How do I report tips to the IRS?
The IRS requires you to report your total monthly tips to your employer by the 10th of the following month. If your employer doesn't have a process for reporting tip income, any staff member who has received tips can use Form 4070 to report those tips to the employer. But you don't have to use that form if the report you submit includes all of the following:
- Your name, address, and Social Security number
- Your signature
- Your employer's name and address
- The month or period the report covers
- The total amount of tips you received during that period
Your employer will pass along your figures to the IRS and take money out of your wages to cover tip withholding.
What if I have unreported tip income?
There are some cases where you may have unreported tip income when filing your income taxes. For instance, if you had months where your tips totaled less than $20 or if you received noncash tips from customers. To report these amounts, you'll fill out Form 4137. The form includes instructions for calculating the Social Security and Medicare tax you must pay on your unreported tip income.
What are the potential penalties for failing to report tips accurately?
If you fail to report your tips to your employer, the IRS can impose a penalty equal to 50% of the Social Security and Medicare tax you fail to pay. And, if you didn't earn enough in wages and tips that your employer pays to you directly to cover your tax withholding, your W-2 will show how much tax you still owe. If the amount you underpay is significant, you have to pay estimated tax penalties after you file your tax return.
``Remember, with TurboTax, we'll ask you simple questions about your life and help you fill out all the right tax forms. Whether you have a simple or complex tax situation, we've got you covered. Feel confident doing your own taxes.