When you work for tips, tracking your income is a bit more complicated than it is for salaried or hourly wage employees — but it’s just as important to properly report your tips when it comes to filing your tax returns.
Whether you’re a bartender, waiter, delivery driver, cleaner or other tipped employee, you need to make sure you’re in compliance with the IRS. Here’s how to deal with taxes when you work for tips.
How is a tip defined?
Tips are defined by the IRS as optional payments that are determined by the customer. Tips of all kinds must be reported as taxable income, whether they are received directly from the customer or as part of a tip-splitting arrangement between employees.
“Tips are income, so they do need to be reported and are taxable. It doesn’t matter what form,” said Josh Zimmelman, owner of Westwood Tax & Consulting.
Service charges imposed by the restaurant are not tips, even if they eventually go to the employee — those are considered regular wages.
“Some gratuities are added automatically, such as for a large party at a restaurant, so even though they’re gratuities, they’re treated as service fees instead of tips,” said Zimmelman.
Keep a record of all tips
It’s a good idea to keep a daily log of your tips. You can use IRS Form 2070A, an optional form provided by the IRS. Alternatively, you can use a spreadsheet or create your own system for logging tips. The IRS also has a calculator that can help you if you're confused.
Some employers and apps provide their own digital method for recording daily tips — for example, the Uber app will track all tips made through the app to drivers (drivers will still be required to track cash tips themselves).
You should keep a record of your tips even if you only occasionally receive them or they don’t make up a majority of your income.
Report tips to your employer
Any employee who receives $20 or more in tips in a month must report tips to their employer by the 10th day of the following month. If the 10th day of the month falls on a Saturday, Sunday or legal holiday, you may report your tips the next eligible day.
Your employer may have a tool for recording your tips, such as a computerized tracking system for daily checkouts. Other employers may require you to fill out IRS Form 4070 on a monthly basis. Employers will use your reported tips to determine how much to withhold from your paycheck.
Depending on your hourly wages and amount of tips earned that month, it’s possible your paycheck may not cover the taxes owed on the tips you brought home. Zimmelman said if that happens, you can either have your employers take it out of your next paycheck or make a payment to the IRS directly. (Check out these tips on what to do if you think you owe the IRS money come April.)
“But you should keep a close eye on these details, so you don’t end up underpaying and get hit with a penalty fee from the IRS,” he said.
Report your tips to the IRS
At the end of the year, your W-2 will contain the amount of tips you earned throughout the year, along with your regular wages and the taxes you paid. You can use this form to file your tax return. (Here are some other forms you should get ready for tax season.)
If there were months when you received less than $20 in tips, you are still required to declare them as income on your tax return. If you received tips of more than $20 but didn’t report them, you will need to fill out IRS Form 4137 for unreported tip income and attach it to your return.
Honesty is the best policy
When it comes to reporting your tips, honesty is the best policy. While you may be able to get away with underreporting tips in some scenarios, this decision could come back to haunt you in a number of different ways:
- IRS penalties: If the IRS learns you purposefully underreported your tips, they will consider it a form of tax evasion. You could be forced to pay taxes on the tips you failed to report, plus a 50% penalty.
- Unemployment income: In many states, unemployment benefits are calculated using the income you made with your previous job. If you lose your job and need to collect unemployment, underreporting tips could cause you to receive fewer benefits.
- Qualifying for financial products: Many lenders verify income when deciding whether to approve loan applications. If you under report your tips, you may not be able to qualify for the auto loans, mortgages or other financial products you want.
Taxes can be complicated — check out this quick guide to filing your taxes to learn more.