Even if you have only received just over $20 in tips in a month while working as an employee, you are required to report to your employer the total amount of tips you have received in full.
You must do this by giving a report in writing to your employer before the tenth of the day of every month, for the preceding month.
Tip amounts lower than $20 don’t need to be reported as tips, but should be reported anyway, included as income on your tax returns.
Tips may be received directly from customers as cash or via other employees as part of a tip-sharing agreement. Tips may also be received as electronic charges via a credit or debit card, and then distributed to an employee.
No matter the method they are bestowed, tips are still tips and must be reported to an employer.
A service charge added to a bill that is mandatory does not count as a tip when it is bestowed to an employee, but does constitute a non-tip wage.
These are subject to the same social security tax, medicare tax and federal income tax withholding that normal wages are.
Employers may not use service charge in their calculations of the credit due to employers, as these are not legally considered tips.
Service charges are commonly considered to be charges such as:
- Large party charge (restaurant industry)
- Bottle service charge (restaurant and night-club industry)
- Room service charge (hotel industry and resorts)
- Contracted luggage assistance charge (hotel industry and resorts)
- Mandated delivery charge (fast food delivery)
Reporting Employee Tax Income As An Employer
In the US it is common custom to tip the service staff in a hospitality industry such as a restaurant. Employers in such industries have an obligation to make sure that these tips are recorded and reported for tax purposes. Responsibilities may include:
- Withholding the income taxes of your employees; as well as social security and medicare etc. based upon the wages and tip income of your employees
- Allocating tips to your employees; additional tips as well if the total reported tips are under a set amount.
- Declaring any and all tips to your employees.
What Are Allocated Tips?
Allocated tips are payments you must make to employees should the total reported tips of a payroll period be less than 8% of the business’ gross sales within the same period.
If you are an employer in a company which is a large food or beverage establishment, then you are responsible for declaring all of the allocated tips of your employees to the IRS.
These large food or beverage establishments are defined as being:
- Located within one of the 50 states or the District of Columbia
- In an industry where the custom is to tip food or beverage employees
- Where, based on the previous calendar year, ten or more employees are working on a typical business day
Should the reported tips be less than 8% of the total gross sales on your receipts, then you as the employer, are required to make up the difference among all tip-receiving employees.
Indicate all of your employees’ allocated tips on their Form W-2 Wage and Tax Statement in the Allocated Tips section. Do not withhold income tax, social security, medicare tax from allocated tips.
Common Misconceptions About Taxing Tips
There are many popular misconceptions regarding taxes and taxes on tips. Many of these misconceptions lead to people being penalized by the IRS for what they don’t really understand.
Below, we highlight some common false truths which you may have heard before:
- That you don’t make enough from tips to be audited by the IRS
The IRS do not care about whether the amount of money you make is small or large, it still all has to be declared- even if it is a seemingly insignificant amount.
The IRS actually harshly come down on service staff because the are aware that it is a common industry for fudging numbers when it comes to declaring tips.
- That tips of less than $20 a month don’t need to be declared
While it is true that reporting tips totaling less than $20 a month to your employer isn’t required by law, all tips, regardless of the amount, are legally required to be declared to the IRS as earned income when filing your income tax return.
- Not declaring your tips can be passed off as a simple mistake
Purposely undeclared income is treated as tax fraud by the IRS and is penalized harshly. 75% of the underpayment will be owed, on top of what was already owed in the first place.
What Is the Punishment For Not Declaring Tips?
When an employee is caught not reporting their tips as a declaration on their federal income tax, it is considered either negligence or tax fraud- and will be penalized either way.
Negligence is penalized with a penalty of up to 20% of the underpayment, while tax fraud, as previously mentioned, is much higher: up to 75% of the underpayment. This can be a devastating blow, particularly if you’re on a hospitality wage.
It is rare for missing tips to be treated as tax fraud the first time you are caught, but they still cause trouble. You will be stringently audited by the IRS from then on.
The fact of the matter is that service industry staff are more stringently audited by the IRS anyway, as there is a known tendency to under-declare tips thanks to poor wages, low managerial supervision, and a high reliance on income from tips.
If you work as a waiter you are far more likely to be selected for an audit purely on the basis of your career.