The most basic section of the U.S. tax code reads: “gross income means all income from whatever source derived.” So, it’s pretty safe to assume you are going to be taxed on any income received, unless there is a specific exclusion you can claim in the tax code. I’m here to tell you today, there is no exclusion for tips. They are taxable and since they are not paid by an employer, the tracking and reporting is important!
So, are tips taxable? In short, yes. Here are four things any person who receives tips needs to be aware of:
1 – All tips are taxable.
While it may seem that tips shouldn’t be taxable because they are not paid by your employer, that is inaccurate. Any tips you receive for services performed are treated just like wages in the eyes of the IRS. All tips, whether received in cash, added to a credit card, or through a tip-splitting arrangement, are subject to tax.
2 – Report all tips.
Because all tips are taxable, that means all tips must be reported on your tax return. In fact, the tips are reported in two locations. First, they need to be reported as part of wages on line 7 of Form 1040. Additionally, you will need to complete Form 4137, Social Security and Medicare Tax on Unreported Tip Income. This form credits the tips to your social security record since the tips were not subject to Social Security and Medicare tax on your W-2.
3 – You are responsible for reporting your tips to your employer.
If you receive more than $20 in tips in any given month, you must report it to your employer by the 10th day of the next month. This amount should include any cash, check, and credit card tips received during the month.
4 – Keep a daily log of your tips.
This can be helpful if the amount reported as tips on your W-2 is higher than what you think it is. If your record differs from what is reported on your W-2, you should report the amount you calculated on the Form 4137. This record will help you prove that your number is accurate if the IRS challenges the reporting.
IRS Publication 1244 is a good template for keeping a daily record of tips if you are unsure of exactly what you need to track.
Now you have the answer to the question “Are tips taxable?” Follow these four steps and you should be good to go! If you have additional concerns, make an appointment at H&R Block and a tax professional can help make sure your tips are reported and appropriately taxed!