If you work in an occupation where tips are received from customers, then they must be reported to the IRS. Not only are they subject to Federal and state taxes but also FICA taxes (i.e., Social Security and Medicare taxes).
While employees should report their tips to their employers so that the appropriate amount can be withheld for these taxes, sometimes they do not. Therefore, they must be declared when filing your tax return.
How to Declare Tips Not Reported to Your Employer
If for any reason you’ve received tips that you didn't report to your employer, then you can declare them when completing Form 1040. Additionally, you must also use Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to settle the employee share of Social Security and Medicare tax owed on those tips.
What Counts as a Tip?
The IRS defines tips as discretionary payments in exchange for a service. This may include:
- Cash tips received directly from customers.
- 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.
- The value of any noncash tips, such as tickets or other items of value.
- Tip amounts received from other employees paid out through tip pools, tip splitting, or other formal/informal tip sharing arrangement.
To ensure that the proper amount of taxes is withheld from your paycheck, employees are encouraged to keep a daily record of the tips they've received and report them at least once per month to their employers (unless the tips total less than $20 for the month). The employer will then combine these tips with their regular wages and summarize this information on the employee’s W-2 in Boxes 1, 5, and 7.
It’s very important to report tips accurately because the penalty could be as much as half of the Social Security and Medicare tax that would have been due if the tips had been reported. In more extreme circumstances it can also lead to an audit of the business as well as other employees.
Please see the IRS webpage Tip Recordkeeping & Reporting for more information.