Americans are a lot more generous with their tips than they were pre-pandemic. According to a recent article from Axios, the percentage of people tipping for remote transactions has jumped from 46% to nearly 86 percent. All tips, including cash, charged amounts, tip pools, and non-cash items are considered income. This means they are subject to income taxes, as well as Social Security and Medicare taxes. If you earn tips, you must report them. Failure to do so could lead to unexpected consequences. To ensure you stay compliant, follow these easy steps on how to report tip income on your tax return.
Earn Tips? You Must Do These Three Things
Working for tips is taxing – literally. There are, however, three things you can do to remain compliant and out of trouble with the IRS.
Keep a Daily Record
It is your responsibility to keep good records and provide sufficient proof of your tip income for the tax year. Keeping a daily log that includes cash and credit card tips, as well as any amounts received or paid through tip sharing is essential. Don’t forget to include the value of non-cash tips, such as tickets, gift cards, or other items of value, as well. Entries in your tip log should include the date received or paid, and the amount. If you paid tips to other employees through a tip pool or other arrangements, be sure to include their names in your log, too.
Service charges, such as delivery charges or automatic gratuity charges for large groups, should not be included in your record. These fees do not count as tips and are typically considered regular wages.
You can record your daily tips in a journal or notebook, or you can easily track your daily tips using IRS Form 4070A. If your employer provides an electronic system for recording your daily tips, be sure to keep a paper copy for your records.
Keeping a daily tip record will help you:
- Accurately report your tips to your employer,
- Keep a good record of your tips for your tax return, and
- Provide evidence of your tip income, just in case you are audited.
Report Tips to Your Employer
Keeping a daily log is just part of the process. If you earn more than $20 a month in tips, report them to your employer using IRS Form 4070. Submit this form by the 10th of every month. If the 10th falls on a weekend or holiday, turn it in on the next business day. Form 4070 includes cash and card (credit or debit) tips received, tips paid out, and net tips for the previous month. Do not report non-cash tip items to your employer. You don’t pay employment taxes on these tips.
In some cases, your employer may require you to submit tip information more than once a month. They use this information to calculate payroll taxes and withhold the appropriate amount from your paychecks. If your hourly wages do not cover the taxes you owe, you can make a tax payment through your employer. You can also request that the taxes be deducted on your next paycheck. To avoid an underpayment penalty when you file your tax return, be sure to keep up with all required tax payments throughout the year.
Report Tip Income on Your Tax Return
Generally, you must report all tips from the previous year on your tax return. This is calculated by taking the amount from box 1 on your W-2 and adding in any tips not previously reported to your employer, including:
- Cash and charge tips you received that totaled less than $20 for any month.
- The value of non-cash tips (tickets, gift cards, passes, etc.)
Do not include any tips reported to your employer in January of this year. Those tips will be included in next year’s tax return. If you use Form 1040 or 1040-SR, include the total of all your tips and wages on line 1.
If you have allocated tips (shown in box 8 of your W-2), be sure to include this amount on Form 1040 or 1040-SR line 1 with all other tips (reported and unreported) and wages.
What If I Have Unreported Tip Income?
Failing to report your tip income can result in a penalty equal to 50% of the Social Security, Medicare, Additional Medicare, or railroad retirement taxes you owe on any unreported tips. If you received $20 or more (cash and charge tips) in a month and didn’t report them to your employer, you must report the employment taxes (Social Security and Medicare) on your return.
Use IRS Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to figure out your Social Security and Medicare taxes. Additionally, you may need to file Form 8959, Additional Medicare Tax. Enter the tax(es) on your return as instructed and attach the completed form(s).
In cases where you did not pay your employment taxes in full on reported tip income, you must include these amounts on your tax return, as well. Uncollected taxes are shown in box 12 of your W-2.
If dealing with tip income and taxes has your head spinning, it’s time to call the professionals. At Tax Defense Network, we can help you prepare your state and federal tax return, making sure you get the credits and deductions you deserve. Don’t risk making costly errors. Give us a call today at 855-476-6920 for a free consultation and quote!