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Chapter 7. Income from Tips

Introduction

This chapter discusses the tax rules for people who receive tips, such as
waiters, waitresses, other food service employees, hairdressers, cab drivers,
and casino dealers. It includes:

∙  What records of tips you should keep,

∙  When and how to report tips to your employer,

∙  What taxes your employer must withhold from your tips,

∙  How to treat tips you did not report to your employer, and

∙  Whether tip allocation affects you and how to report your tips if your
   employer allocates tips.

All tips you receive are taxable income and are subject to federal income tax.
You must include in gross income:

1)  All tips you receive directly from customers,

2)  Tips from charge customers that are paid to you by your employer, and

3)  Your share of any tips you receive under a tip-splitting arrangement.

Withholding tax on tips. Cash tips of $20 or more that you receive in a month
while working for any one employer are subject to withholding of income tax,
social security or railroad retirement tax, and Medicare tax. Report the
tips you receive to your employer so that the correct amount of withholding
taxes can be determined. This is explained more under Withholding on Tips by
Employer, later in this chapter.

Social security or railroad retirement benefits. Your tips and other pay
are used to determine the amount of social security or railroad retirement
benefits you or your family may receive if you retire, become disabled, or
die. You can get information about these benefits from Social Security or
Railroad Retirement Board offices. Noncash tips are not counted as wages
for social security or Medicare purposes.

To ensure that your future benefits are figured correctly and that you have
received credit for all your earnings, you should request a statement of your
earnings from the Social Security Administration periodically. You can get
your earnings statement by calling 1─800─SSA─1213.

Related publications and forms.

This chapter refers to several publications and forms that you may need. The
list of forms does not include Forms 1040, 1040A, and 1040EZ. For more
information you may want to order the following.

       Publication 531, Reporting Income From Tips

       Publication 1244, Employee's Daily Record of Tips (Form 4070─A) and
       Employee's Report of Tips to Employer (Form 4070)

       Form 4137, Social Security and Medicare Tax on Unreported Tip Income

Reporting Tips

You must report all tips as wages on Form 1040, Form 1040EZ, or Form 1040A,
including the value of tips not paid in cash, such as passes, tickets, goods,
or services. However, if you received tips of $20 or more in a month and
you did not report all of them to your employer, you must file Form 1040.

Service charges. A club, hotel, or restaurant may require customers who use
its dining or banquet rooms to pay a service charge, which is given to the
waiters or waitresses and other employees. Your share of this service charge
is not a tip, but it is part of your wages paid by the employer. You should
not include your share of the service charge in your report of tips to your
employer. Your employer should not include your share of the service charge
in tips paid to you, but should include it in your wages.

Daily Record of Tips

You must keep a daily record or other documentation to prove the amount of
tip income you report on your return.

Daily record. Your daily record must show the following:

∙  Your name and address,

∙  Your employer's name, and

∙  The establishment's name.

   Also show for each workday:

∙  The amount of cash and credit card tips you received directly from
   customers or from other employees,

∙  The amount of tips you paid out to other employees through tip sharing,
   etc., and

∙  The names of the other employees to whom you paid tips.

Make the entries in your daily record on or near the date you receive the tip
income.

Other documentation. If you do not keep a daily record of tips, you must
maintain other documentation of the tip income you receive. This other
documentation must be as credible and reliable as a daily record. This
other documentation can be:

∙  Documentary records that show tips added to a check and paid over to you,
   or

∙  Amounts paid for food or beverages on which you would generally receive a
   tip.

   Examples of documentary records are:

∙  Copies of restaurant bills,

∙  Credit card charges, or

∙  Charges under any other arrangement containing amounts added by customers
   as tips.

Which form to use. You can use Form 4070─A to record your tips.

Form 4070─A can be found in Publication 1244. You can get Publication 1244
from the IRS or your employer.

Your personal records. You should keep your daily tip record and a copy
of the written reports you give your employer with your personal records.

When to Report Tips to Employer

You must give your employer a written report of your tips for each month by
the 10th day of the next month. This report is required for each month that
you receive tips of $20 or more while working for that employer.

Saturday, Sunday, holiday rule. If the 10th day of the month falls on a
Saturday, Sunday, or legal holiday, you may give your employer the report
on the next day that is not a Saturday, Sunday, or legal holiday.

How to Report Tips to Employer

The following discussions refer only to tips paid by cash, credit card, and
check.

Less than $20 in tips in one month. If you receive less than $20 in tips while
working for one employer during a month, you do not have to report them to
that employer. But you must include the tips in gross income on your income
tax return. You do not have to pay social security, Medicare, or railroad
retirement tax on these tips.

$20 or more in tips in one month. If you receive tips of $20 or more in a
month while working for any one employer, you must report the total amount
of your tips to that employer by the 10th day of the next month.

Example 1. You work for Watson's Restaurant during the month and receive $75
in tips. Because your tips are more than $20 for the month, you must report
the $75 to your employer.

Example 2. You work for Watson's Restaurant during the month and receive $17
in tips. In that same month you work for Parkview Restaurant and get $14 in
tips. Even though your tips total $31, you do not have to report them to
either employer because you received less than $20 in tips from each job.
However, you should keep a record of the $31 because you must report it as
income on your tax return.

Tip splitting. If you split tips with fellow employees, such as waiters giving
a part of their tips to busboys, include only your share of the tips in your
report to your employer. "Tip splitting" may also be referred to as "tip
sharing" or "tip pooling."

Your tip report to your employer should cover only one calendar month. But,
your employer may require you to report your tips more often than once a
month. For example, you may be required to report your tips weekly. In
this case, you must make your report on the dates set by your employer.

When you stop working for your employer, you should report your tips of $20
or more to your employer at that time. If you do not report the tips when you
stop working, you must give a statement to your employer either before your
final payday or by the 10th day following the month you receive the tips,
whichever is earlier.

Your tips are treated as paid to you when you make your written report to
your employer. However, if you make no report to your employer, your tips
are treated as paid to you when you receive them.

Example 1. During December 1992, you received $300 in tips. On January 10,
1993, you reported the tips to your employer. Your December 1992 tips will be
treated as paid to you in January 1993, at the time you made the report to
your employer. You must report the $300 on your 1993 income tax return.

Example 2. If during December 1992 your tips were only $18, you would not have
to make a report to your employer. In this case your tips are treated as paid
in December 1992, the time you actually received them. You must report the $18
on your 1992 income tax return.

To report tips to your employer, you may use Form 4070, Employee's Report of
Tips to Employer. This form, available in Publication 1244, tells you what
information you must report. If you do not use Form 4070, your report should
include the amount of the tips, your employer's name and address, and your
name, address, social security number, the month (or shorter period) covered,
signature, and the date of the report.

Publication 1244 is a booklet containing several copies of both Form 4070 and
Form 4070─A for your use.

Withholding on Tips by Employer

Your employer must withhold social security or railroad retirement tax,
Medicare (hospital insurance) tax, and any income tax due on the tips you
report. Your employer usually deducts the withholding due on tips from your
regular wages. But you do not have to have income tax withheld if you can
claim exemption from withholding. You can claim exemption only if you had
no income tax liability last year and expect none this year. See Exemption
From Withholding in Chapter 5 for more information.

Employer's recordkeeping. Your employer may withhold an estimated amount from
your wages to cover the tax on your tips. Your employer also may require your
written tip reports more than once a month and may deduct the taxes due on
your reported tips even though they do not yet total $20. If this is done,
your employer must adjust the amount of taxes withheld from time to time,
based on the actual amount of tips you report.

Form W─2. The Form W─2, Wage and Tax Statement, which you get from your
employer, includes your reported tips in your regular wages. It shows
separately your social security wages and tips and your Medicare wages and
tips. These amounts are included in the "wages, tips, other compensation"
block (box 10) of the form. The form also shows the social security, Medicare,
and income taxes withheld on your tips. Any errors you find in these amounts
should be brought to your employer's attention as soon as possible so you
can obtain a corrected form.

Pay too low. If your regular pay is too low for your employer to withhold all
the tax due on your pay plus your tips, you may give your employer extra money
to pay the tax. Your employer will give you a written statement telling you
how much is needed.

If you do not give your employer enough or any extra money, your employer will
first withhold as much social security or railroad retirement tax or Medicare
tax as possible, and then withhold income tax up to the full amount of your
pay.

You may pay estimated tax instead of giving your employer extra money. See
Chapter 5 for information on estimated taxes.

Uncollected employee social security and Medicare tax on tips. Box 17 (code
A) on your Form W─2 will show the amount of social security tax on tips that
your employer was unable to withhold and for which you did not give your
employer extra money to pay the tax.

Box 17 (code B) will show the amount of Medicare tax on tips that your
employer was unable to withhold and for which you did not give your
employer extra money to pay the tax.

You must file Form 1040, to report the amount of uncollected tax on tips from
Box 17 (code A or B) Form W─2 and pay it with your return, even if you do not
otherwise have to file a return. Include the amount of uncollected employee
social security and Medicare or railroad retirement tax on tips in the
total on line 53 of Form 1040. On the dotted line next to line 53, write
"Uncollected Tax" and show the amount.

Limit on social security and Medicare tax. The pay you received and the
tips you reported to a nonrailroad employer in 1992 were subject to the
withholding of social security tax at the rate of 6.2% on the first $55,500
of compensation and Medicare (hospital insurance) tax at the rate of 1.45%
on the first $130,200 of compensation.

No more than $5,328.90 ($3,441.00 for social security tax and $1,887.90 for
Medicare tax) should have been withheld from your pay by any one employer.

Limit on railroad retirement tax. If your pay and the tips you reported to
your railroad employer in 1992 were subject to the withholding of tier 1
and/or tier 2 railroad retirement tax, then see the following discussions.

Tier 1. Your employer withheld tier 1 railroad retirement tax at the rate
of 6.2% on the first $55,500 of compensation. Your employer also withheld
Medicare tax at the rate of 1.45% on the first $130,200.

No more than $5,328.90 ($3,441.00 for tier 1 railroad retirement tax and
$1,887.90 for Medicare tax) should have been withheld from your pay by any
one employer during 1992.

Two or more employers. If you worked for two or more employers in 1992,
who together withheld more than $3,441.00 of social security tax or tier 1
railroad retirement tax, $1,887.90 of Medicare tax, you may claim the extra
amount as a credit to reduce your income tax when you file your return.
See Excess Social Security, Medicare, or Railroad Retirement Tax Withholding,
in Publication 505 for more information.

Tips Not Reported to Employer

If you received tips of $20 or more in any month while working for one
employer, but did not report all of them to your employer, you must figure
your social security and Medicare tax on the tips not reported. You should
use Form 4137 and attach it to Form 1040. Enter the tax on line 50 of Form
1040. You also must include these tips in income on line 7 of your Form 1040.
You may not use Form 1040EZ or Form 1040A.

Do not use Form 4137 for tips received for work covered by the Railroad
Retirement Tax Act.

Employees subject to the Railroad Retirement Tax Act. If you received tips
of $20 or more in any month while working for a railroad employer and did
not report them to your employer, you should contact your nearest Railroad
Retirement Board office for information on how to determine the amount of
railroad retirement tax on unreported tips and how you can get railroad
retirement credit for all your tips. You should pay the railroad retirement
tax on unreported tips when you file Form 1040. Enter the tax on line 50
of Form 1040 and write "RRTA" next to it on the dotted line. You also must
include these tips in income on line 7 of your Form 1040. You may not use
Form 1040EZ or Form 1040A.

Penalty for failure to report tips. If you do not report tips to your employer
as required, you may be subject to a penalty equal to 50% of the employee
social security or railroad retirement tax, and Medicare tax in addition to
the tax that you owe.

If you did not report tips to your employer as required, you should attach a
statement to your return explaining why you did not report them.

Tip Allocation

Large food or beverage establishments are required to report to the IRS
certain additional information about tips.

To make sure that employees are correctly reporting tips, employers must
keep records to verify amounts reported by employees. Certain employers must
allocate tips if the percentage of tips reported by employees falls below a
required minimum percentage of gross sales. To "allocate tips" means to assign
an additional amount as tips to each employee whose reported tips are below
the required percentage.

How the rules work. If the rules on tip allocation apply to your employer's
establishment, your employer may have to allocate to you a part of the
difference between 8% (or some lower acceptable percentage) of the total
sales of the operation and the amount of tips reported by all tipped employees.
However, no allocation will be made to you if you report tips at least equal
to your share of 8% of total sales.

If the customers do not tip 8% on the average, either your employer or a
majority of the directly-tipped employees may petition to have the allocation
percentage reduced from 8%. However, it cannot be reduced below 2%.

Allocated tips on Form W-2. Your employer will report the amount of tips
allocated to you on your Form W─2 (in Box 7), separately from your wages
and reported tips. Your employer bases withholding only on wages and reported
tips. Your employer should not withhold income, social security, railroad
retirement, or Medicare tax from the allocated amount. Any incorrectly
withheld taxes should be refunded to you by your employer.

Note. Regardless of whether you receive a tip allocation, you are required to
report as income all tips received. The tip allocation amount may be added to
your gross income unless you are able to prove a lesser amount with adequate
documentation. The IRS may determine that you received a larger amount of tip
income than is reflected by the tip allocation.

For more information on these requirements, see Tip Allocation in Publication
531.