Posted by Jim McClaflin, EA, NTPI Fellow

Reporting Tip Income: Everything you should know

Reporting Tip Income: Everything you should know

All workers and employers in the service industries where tips occur should abide by the relevant tax rules. One needs to pay income tax, Medicare tax, and Social security taxes on dividends, like regular wages. Here is the essential guide that can direct you on how to go about reporting tip income.


Basics of Tips income 

We refer to tips as discretionary payments that customers pay workers in cash, noncash, credit cards, etc. A tip income needs to be voluntary and the amount un-negotiated.

As long as the total tip received for a month is above $20, employees must report the entire cash tip. It should be reported by the 10th of the following month, following when the tip was received. Noncash tips will not be reported.

The gross income of an employer will typically contain cash and noncash tips, which are subjected to tax. One needs to report both direct and indirect tips to the employer. However, it is possible to reduce the number of tips you share with fellow employees. 


Requirement for Employers 

  • Collate tip report from an employee

  • Withhold the FICA taxes (employee taxes) and income taxes from employee

  • Pay FICA taxes (employee share)

  • File essential forms like Form 941 with the federal deposit

  • Report tip income on Form W2 (Tips, wages, and compensation, box 1) while you report Medicare tips and wages on Box 5 with Social security tips on Box 7


Tips Allocated 

For any establishment (like a beverage shop or large food outlet) with total tips reported by all employees below 8% of the entire gross receipts, the employee will allocate the specified difference between actual tip income alongside the 8% of gross receipts, distributed among all employees who got the tips.

For any tip allocated by the employer:

  • They will be reported on Form W2 – allocated tips on Box 8

  • They will not be reported in Boxes 1, 5, or 7. This is because income tax and FICA are not withheld, and the employee did not report the amount to the boss



Large beverage and Food Outlets 

All employers operating a large food outlet or beverage needs to file Form 8027. This is the Employer's Annual Information Return of Tip Income and Allocated Tips. This report will include all receipts from beverages, foods, tips that the workers report, alongside all allocated tips. 

An outlet is considered a large establishment (food or beverage) provided the following conditions are satisfied:

  • They have a presence in all states of the US or DC

  • There are food or beverages available for consumption on the compound. This does not include fast food operations

  • It is usual for employees to get tips for food and beverages

  • The employers have over ten employees on any business day. 



Unreported Tips: Employer’s Share of Medicare and Social Security taxes for Unreported Income

For a worker that did not report their tip to the boss, the boss is not responsible for the Social security and Medicare taxes for the unreported tips. When Uncle Sam, however, notifies and requests for the taxes, this changes. 

The employer will not be held responsible for removing and making payments for the Medicare and Social Security taxes on tips that were unreported. 


Compliance Agreements Voluntary Tips 

Uncle Sam sets up voluntary tip compliance for firms where tipping is essential. This includes restaurants and bars. 

With this agreement, the worker and employee know their responsibility and what is expected of them. This happens by education and not an enforcement or other strict means by Uncle Sam. 


Conclusion 

On a final note, one needs to treat and consider tip income like wages. Make sure to remain compliant with the requirements to avoid hassles with the law. 


FOR MORE INFORMATION OR TO SEE HOW JIM McCLAFLIN, EA, NTPI FELLOW CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLICK THE BLUE TAB ON THIS PAGE.


THANKS FOR VISITING.

Jim McClaflin, EA, NTPI Fellow
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