Savvy Tax Moves: Reporting Tips on Taxes

Restaurant workers living paycheck to paycheck might not be aware of their obligations for reporting tips on taxes. They may think it unnecessary to report what’s merely a fraction of their overall earnings. But make no mistake; failing to report your tips as taxable income could be a fatal error for your finances, whether you’re an employee or a manager.

How do restaurateurs and their employees handle tips and gratuities? Here’s a primer on how to approach reporting tips on taxes.

What Is Considered a Tip?

In the food service industry, a tip is any kind of gratuity or extra money that a customer provides to wait staff as appreciation for their service. There is no standard percentage for leaving a tip, although the general rule of thumb is to leave 15% to 20% of your final bill as a tip.

In some restaurants, the tip is figured into the total bill. This practice is particularly common in upscale restaurants as an essential part of their top-flight service or in situations where the party being served has six or more people. 

Are Tips Taxable?

As part of a waitperson’s gross income, tips and gratuities are considered to be taxable income. They are viewed as compensation for a provided service even though the revenue does not come directly from the employer.

Therefore, both employees and their employers must account for tips and gratuities on their annual tax income returns. Generally, tips are taxed at the same rate as regular earnings. 

How to Report Tips on Taxes?

Both employees and their employers must report tips on their annual income tax returns. The process is a little different depending on whether you’re the employee or the boss. 

For Employees

If you earn more than $20 in tips in a month, the IRS requires you to report them as taxable income to your employer by the 10th of the following month. Here is a breakdown of the steps.

Keep Daily Tip Records

Calculate how much you’ve received in tips at the end of your working day. Enter them on a log that you’ll update throughout the tax year.

Report Tips to Employer on IRS Form 4070A

Prepare a monthly report on your earnings from tips. This report should be ready to go to your employer by the 10th of the month after the one you’re reporting for. You should use IRS Form 4070A (Employee’s Daily Record of Tips) to keep track. The form is available on the web if your employer doesn’t already have one for you.

Include Tips as Annual Gross Income

At the end of the year, add your cumulative tips and gratuities to your annual gross income. Instead of having a separate line item for tips, it’s simpler to just add them to your total earnings.

Report Tips on Your Tax Return

After your employer has sent your W-2 — hopefully by the end of January — double-check Box 7. This should contain the amount of tips you’ve reported to your employer over the year. On your tax return, include all tips, whether reported or not. Use IRS Form 1040, which has complete sections dedicated to tip income.

There are slightly different calculations made on tips when it comes to funding Social Security and Medicare. While it’s helpful to know what they are, you shouldn’t worry about the distinction as long as you issue accurate income reports. However, do keep on top of state reporting requirements, as they can change. And if you’re part of a tip-sharing agreement, make sure your cut is reported as income.

Retain All Your Records

This goes for practically any kind of transaction. Keep copies of your reports, tax records, paystubs, and tip logs, and put them in a safe place so they’re ready if someone requests to see them.

For Employers

As the employer of staff members who customarily receive tips, you might be depended upon to know how tip reporting works and what your staff needs to do. Your restaurant business, however, is on the hook for other obligations as well.

Understand Reporting Requirements

Know your restaurant’s tax reporting needs in advance before you take on employees. They may eventually ask you what they have to do to remain compliant, so it’s a good idea to get a firm grasp on the rules beforehand.

Establish a System for Employee Reporting

One way to make employee reporting easier is to set up a system or process, whether by manual or digital entry. Whichever submission solution you arrive at, make sure it’s secure and that each entry is only accessible to you and the employee reporting. Remember, all income reports should be submitted by the 10th of the month. 

Provide Forms

If you want to take that extra step — and potentially win some favor from your staff — you can provide your employees with the requisite forms they need to report their tips. This simply involves downloading multiple copies of a blank Form 4070 and distributing them as necessary or requested.

Collect and Record Tips

As your employees submit their monthly tip reports, gather them, add them up, and add them to your monthly report. If you’ve started a tip-sharing system, report all the allocations accurately.

Include Tips in Wages

Remember to add the total tips and gratuities to your annual gross wages figure. 

Withhold Taxes

According to state and federal limits, withhold employees’ earnings for Medicare, Social Security, and income tax if needed. This is standard practice for all American employers.

Issue W-2

Arrange your employees’ W-2 forms for the year and make sure to send them out in time for them to fill out their tax returns.

Retain Records

With employers, it’s even more important to keep records of your employees’ tips and tax records. Keep them in a safe place, or let your accountant hold on to them.

What Happens if You Don’t Report Tips?

Though they may make up a fraction of your gross income, tips must be reported to the IRS and responsible parties. The ramifications of not doing so can be difficult to endure.

Employees

An employee who doesn’t adequately report their tips can be subject to the following:

  • Penalties and interest on underpaid or unpaid taxes
  • Credit score downgrade, which could impact loan or rental applications
  • Loss of Social Security or Medicare benefits
  • An IRS audit, as well as close monitoring by the IRS in the future
  • In extreme cases, possible criminal liability
  • Mistrust or suspicion from your employer

Take time to streamline your tip reporting to avoid this kind of fallout.

Employers

Employers who fail to report tips face dire consequences that could affect their liability:

  • IRS audits, fines, and Form 8027 penalties
  • Loss of “tip credit,” which employers can use to offset minimum wage requirements
  • Loss of business license in some jurisdictions
  • Reputational damage among customers, peers, and employees
  • Complications when it’s time to sell the restaurant

It may be even more crucial for employers to stay on top of tip and gratuity concerns.

How to Catch Up on Unreported Tips?

If you’ve gotten underwater on your tip reporting, you can get yourself back to the surface, even if your tardiness goes back a couple of years.

Compile and Calculate Unreported Tips

Include a detailed list, if possible, of your monthly tip history. Determine the sum of all the tips you haven’t reported yet.

Report Findings to Your Employer

Let your employer know the results of your search. Check with your payroll department to ensure that you’ve reported your tips properly and submit them for their approval.

Request a Corrected W-2

When your employer has accounted for your missing tips, ask them to redo your W-2 form so you can start over with reporting.

File an Amended Tax Return

If necessary, refile your tax return with the IRS. An explanatory letter may be helpful, too.

Calculate and Pay Back Taxes

Find your tax liability on unreported tips. Pay them back, or arrange with the IRS to set up a payment plan.

Get Clarity on Reporting Tips on Taxes

Are you feeling the pressure of unreported, under-reported, or overlooked tips that can come back to haunt your tax status? doola’s tax experts can give you professional assistance in being and staying compliant. Contact us for a free consultation

FAQs

Do I need to report non-cash tips?

Yes! If you receive a physical gift or non-cash tip equivalent, report the fair market value of the item on your tax return.

Are there any deductions available for tipped employees?

You don’t need to report monthly tips if they do not exceed $20, although it’s not a bad idea to do so anyway. Beyond that, there are no deductions specifically for tipped employees.

Do I have to report tips if I receive them from family or friends?

If you receive tips from family or friends while working at your place of employment, you do indeed have to report them.

What if I receive tips through a digital platform or app?

Yes, those tips are taxable and reportable, too. Many mobile apps have functionalities that will add your tips automatically, so make sure you know how to use them.

Can I report tips from previous years on my current tax return?

No! However, you can file additional, amended tax returns for previous years to include tips from those periods.

doola's website is for general information purposes only and doesn't provide official law or tax advice. For tax or legal advice we are happy to connect you to a professional in our network! Please see our terms and privacy policy. Thank you and please don't hesitate to reach out with any questions.

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