Tax Treatment for Tips
For many service industry employees, such as waitstaff and hairdressers, some or all of their compensation is paid through tips or gratuities. Section 61 of the Internal Revenue Code takes a broad approach to the definition of income. Your individual taxes require you to report all income you receive no matter what the source. Cash and noncash compensation will constitute income unless it is specifically excluded based on an exception in the Internal Revenue Code.
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How Do Tips Factor Into Taxes?
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Since the Internal Revenue Code takes a really expansive view of what constitutes income, both cash and noncash tips and gratuities are considered income. Because they are income, they are subject to federal income taxes and must be reported on your tax return. These tips are also subject to Social Security and Medicare taxes as well.
How Do I Report Tips?
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If you receive more than $20 in tips per month, the IRS requires that you report this tip income to your employer as your employer is required to withhold taxes as well as Social Security and Medicare taxes on these payments. If you do not report your tips to your employer, and your employer does not otherwise keep track of this information, you could be held liable for a penalty equal to 50 percent of the Social Security and Medicare taxes that you owe on the unreported tips.
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How Do I Keep Track of Tips for Taxes?
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You are permitted to keep track of these tips in any manner that you see fit provided that you are keeping track. Some employers have systems in place for their employees. The IRS has created a template that you could use to keep daily records of your tips in Publication 1244. The record contains information about the amounts received, dates received, whether the tip was shared and the name of the person with whom the tip was shared, if anyone.
What Happens If I Tip Out Other Workers?
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If you are required to tip out other workers, you should keep track of this information on your daily record. You are not allowed to deduct these tip outs to other workers; however, if you have documentation that you have tipped out a coworker, then you will not need to include that amount in your gross income.
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- Photo Credit waiter setting table in restaurant image by Stephen Orsillo from Fotolia.com
