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Tips and Taxes: IRS Reporting Requirements

Tips and Taxes: IRS Reporting Requirements

Tips and Tax Rules, as specified by the IRS can be confusing.  This is especially so if you are not accustomed to the language and forms used by the Internal Revenue Service.

Tips and Taxes

In this article, Gavrilov & Co gives you the low-down on requirements that you face paying taxes on Tips.  If you work in food service, the beauty industry, or in any other profession that receive tips as part of income, you have some very special tax reporting requirements.  This blog notes some of the major income tax requirements you must satisfy when you file.

Most of us are aware that employees who receive tips in eating establishments have to pay tax on them.  Did you ever wonder, “How can the IRS possibly know if that employee reports truthfully?”

Some of us might assume that a “Tip” is cash that is simply slipped into a pocket or purse.   And therefore, it doesn’t get taxed.  We might even wonder who if employees are honest enough to report every taxable tip dollar.

However, there are some controls, safeguards, and rules that govern employee’s tips.

Employee Responsibilities:  Tips Are More Than Just Cash

Good Tips or Poor:  They must be reported.

Special Night Out, Special Meal, Special Service: It’s Worth a Good Tip.

Frank and Barbara enjoy a scrumptious steak dinner at Joe’s Hideaway. (Fictional Restaurant name, of course.)  The meal is delicious and the server, Laura, is charming and provides perfect service.

So, while Frank is finding the right credit card, he remembers, he has an extra ticket for the musical “Pretty Woman” in Manhattan.

The meal Frank and Barbara had enjoyed was $150.00, which he paid with his credit card.  The couple had no one else to give the musical ticket, and the polite, perfectionist waitress had made dinner very enjoyable.  So, with a wink and a consenting nod from Barbara, he gave her the ticket and a 30.00 cash tip to Laura.

Question:  Is the Laura, the server, responsible for taxes on only the $30 cash?

Answer:  If you answered “Yes” to this question, then you answered wrong. Laura must report taxes on the 30.00,  plus the value of the play ticket.  In this case, the ticket normally sold for $189.  You may not have to report the play ticket to your employer, but it must be reported on your income tax.

What is a Tip According to the IRS?

The IRS says that a tip is “discretionary.”  It is an optional or extra payment that is “determined by a customer that employees receive from customers.”  These are additional payments for service which are determined solely by the customer.

Tips, Reportable as Taxable Income

The Internal Revenue Service states that a tip includes the following areas.

  1. A Non Cash Tip, Like Tickets to a Play is still taxable

    High 5 Congratulations For a Shared Job, Well Done

    “Cash tips received directly from customers.

  2. Tips from customers who leave a tip through electronic settlement or payment.  This includes a credit card, debit card, gift card, or any other electronic payment method.”  Example: Look at a credit billing ticket.  You have a block for the amount for the service, one for the tip and finally the total amount.
  3. “The value of any – tip income, such as tickets, or any other items of value.”
  4. “Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip-sharing arrangement.”

Employee Responsibilities In Maintaining Tax Records

There are rules and regulations that an employee must follow concerning tips.  The employee is responsible for maintaining daily records which show all of the tip-amounts received.  It is important that you keep the records accurately and professionally.  Please note:

  • They are used to Report your tip income accurately to your employer.
  • You must Report your tip income accurately on your tax return.
  • And you must be able to prove your tip income if you are ever audited or questioned.

If you work as a restaurant server or perform services in a hair salon or any profession involves tips, you must maintain the daily report.  There are two ways to set-up and keep this report.

1.    You may keep a Tip journal or diary.

Each day, you must record all tips that you receive.  A typical page in your record would probably include the date and amount of tips you received.

  • It should show the dollar amount of tips received in cash and the amount on credit cards.  The two amounts should be kept separate.
  • If you share a tip with another employee, you should record the amount that you paid to the other employee by name.
  • Additionally, you need to list separately the non-cash tips that you received and their value.

2.   The 2nd method involves using forms provided by the IRS.

“To help you keep a record or diary of your tips, you can use Form 4070A, Employee’s Daily Record of Tips.  To get Form 4070A, ask IRS or your employer for Pub. 1244, Employee’s Daily Record of Tips and Report to Employer.”  This includes “a 1-year supply of Form 4070A.”

The advantage of using the government form is that there is a detailed publication that guides and provides illustrations of the required information.  And of course, a second advantage is that it is already set-up and printed for you.

Social Security and Medicare Taxes

Ladies Day Out

The tips that you report to your employer each month are also subject to Social Security and Medicare.  So, that is still another reason to keep accurate daily records.

All cash tips that you receive (as an employee) are also “subject to social security and Medicare taxes.”  And they “must be reported to the employer.”  The exception:  If you have a month that you receive less than $20 in tips.  And you must  report by the 10th of each month.

Remember cash tips include the following categories.

  1.  Tips received from customers,
  2. Charged tips such as credit and debit card charges.
  3. Tips “distributed to the employee by his or her employer,
  4. And tips received from other employees under any tip-sharing arrangement.”

Do Not Report Service charges as a “Tip”

Record Keeping is important.

Shared Tips: Time to Divvy-up the Loot. Be Sure to Record the $$$.

You do not need to record Service Charges, added to a bill by the manager of your restaurant. If he pays them to you as wages, they are not tips.  Thus, you need not not add service charges to your tip diary.

“This is part of your wages, not a tip.”  The IRS has provided these guidelines to help you decide if the charge is a “tip or service.”  Check out these requirements for the legal definition of a “tip:”

  • “The payment is made free from compulsion.
  • The customer has the right to determine the amount of payment.
  • The payment isn’t subject to negotiation or dictated by employer policy.
  • And the customer generally has the right to determine who receives the payment.

Your final task in regard to gratuities is to file your Tax Return, based on your meticulous records.

Thank you for reading our blog and please return for additional news and information Tax Squad from at Gavrilov & Co.