Tips on Tip Income

Photo by Roman Kraft on Unsplash

I have many clients who work in entertainment services like waiters, tour guides, Share riding drivers, hair dressers, makeup artists, etc and many of them do not know the legal requirements for reporting tips.  I do, however, have one client, who as a result of an audit, now complies fully.

And that’s why today, based on one client’s experience, I want to give you some “tips” on Tips so to speak.  As always I preface this post with the directive that ALL income from ALL sources is reportable to the IRS with very few exceptions – Tips are not an exception.

  1. If you receive tips in excess of $20 per month, you are required to report those tips to your employer. – Now hold on, that doesn’t mean you don’t include $20 or less in monthly tips on your taxes, you do – you just don’t need to inform your employer.  What’s the benefit of this?  Employers are required to withhold taxes on your tips so at the end of the year you won’t have to come up with additional cash to cover the tax on that income.  But an added benefit is that the Employer will pay half of your Social Security and Medicare Taxes on all reported income.  And why not have your employer pitch in half the cost?
  2. You should be keeping a daily log of your tips.  If you need help in keeping track the IRS provides a worksheet for you to keep that might help using Pub 1244.  I LOVE worksheets and lists, etc so of course I find this quite helpful.  Here’s why this is important – when you get to audit and you don’t have any type of record you are subject to the auditors discretion based on their auditing guide which is produced by statistics over a wide swath of the US taxpayers in the same industry.
  3. Allocated tips – If the tips that are reported to an employer fall beneath 8% of table charges, the employer will be compelled to “allocate” the difference in tips among the employees, whether you got it or not.  A great way to adjust this on your return would be to have accurate and contemporaneous records.

To report your tips and make any adjustments based on your contemporaneously kept records, you will file Form 4137 with your income tax return.  Here’s the kicker – if you don’t report to your employer appropriately you have to claim your tips here anyway.  You still pay your share of income tax and social security tax, your employer doesn’t have to contribute AND… you could be penalized for not complying with the tax rules regarding reported tips up to 50% of your Social Security assessment.  On top of that, you may be audited – and try to explain that your job title is waitress, bartender, hair dresser, etc but you didn’t receive any tips. It won’t end in your favor and you may be assessed far more than you ever got.  With no records and by not reporting the income in the first place, your word will not buy much latitude as might otherwise be granted in the argument.  The Social Security Administration is having a difficult time covering all the retirees based on current contributions.  They are looking deeper into all the different ways people are avoiding paying the social security taxes so be aware, this is NOT a good tactic to take to save money.

Those are the basics, if you have any questions please feel free to comment or contact us.

We’ll chat again soon –


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