Posted by Fred Lake

Tip Money is Taxable Income

Tip Money is Taxable Income

For people in the line of work where they receive tips typically, money is an essential part of their income. 

The internal Revenue Service, however, makes it compulsory that tip payment should be taxed. This makes it essential to know what Uncle Sam expects of you in terms of reporting tip income to prevent you from getting a strange tax bill during the tax period. 


Employees need to report Tips to their Employers. 

Receiving more than $20 per month as a tip qualifies for tax. As a result, one needs to report such amounts (including tips from credit cards and cash) to the employer. Workers can note the amount using Form 4070 – Employee’s Report of Tips to Employer. You need to hand this form over to the employer on the 10th day of the following month that you got the tip.

The employer is responsible for reporting the tip income on the worker's Form W2- Wage and Statement of Tax to Uncle Sam. Workers will also get a copy of this form by the year-end. 

Also, the employer will remove the portion of Medicare and Social Security taxes from the tip income.


The tax on Your Tip Income Could be More than You Reported 

There are cases when the entire tax tip reported from workers will not be up to 8% of the whole gross sales. Uncle Sam, in this instance, assumes that they did not report all tips. In cases like this, the IRS mandates the employer to distribute the unreported tip tax among the workers.  

Such tip money allocated by the employer will be listed on Form W2 Box 8 called Allocated Tips.

Provided you have proof to show that what you got is lower than what is on your tax return; you can report the exact amount on your tax return. However, you need to maintain a daily record of the tips you got alongside other verifiable evidence. As a result, keeping records of all tips you got is critical.


Unreported Tip Income Might Cost you Social Security and Medicare Taxes.

According to the IRS, one needs to pay Medicare and social security tax on all unreported tip income. Form 4137, Social Security and Medicare Tax on Unreported Tip Income, can help estimate this amount, 

Employers and Tip Income

There are federal regulations on tip income that employers must comply with. This involves collecting income tax, Medicare tax, and Social security tax on all tip income. The entire tip income reported must not be less than 8% of the whole sale on the employer's result in any month. 

While tipped employees need to report all the tips they got, it does not always work that way. As a result, employers have the responsibility of making sure their workers follow specified regulations. 

Here are some tasks related to tips for employers, as suggested by the IRS. 

  • Informing, training, and educating all workers on the right way to report their tips

  • Collecting such tip reports from all workers once a month at least

  • Paying the state income tax and FICA on all tip income from employee

  • For a restaurant or bar with more than ten workers and tips flow regularly, the owner needs to file Form 8027

  • Making sure that the entire tip reported by all the workers satisfies the minimum threshold set by the federal government – 8% of gross receipts

  • Confirming that any worker's report that does not meet the set minimum threshold has their facts and records right. This involves applying for a notable exception with Uncle Sam.

There are businesses like bars and restaurants where employers provide a lower hourly wage since they assume workers will earn a tip. For all workers that get a tip above an absolute value, one needs to report it to the employer and Uncle Sam because such taxes are not withheld like other regular income.


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Fred Lake
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