Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers.
Tips include:
- Cash tips received directly from customers.
- Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
- The value of any noncash tips, such as tickets, or other items of value.
- Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangement.
All cash and non-cash tips an employee receives are income and are subject to Federal income taxes. All cash tips received by an employee in any calendar month are subject to social security and Medicare taxes and must be reported to the employer, unless the tips received by the employee during a single calendar month while working for the employer total less than $20. Cash tips include tips received from customers, charged tips (e.g., credit and debit card charges) distributed to the employee by his or her employer, and tips received from other employees under any tip-sharing arrangement.
Employee Responsibilities
As an employee who receives tips, you must do three things:
- Keep a daily tip record.
- Report tips to the employer, unless less than $20.
- Report all tips on an individual income tax return.
Keep a daily tip record
Employees must keep a daily record of tips received. You can use Form 4070A, Employee’s Daily Record of Tips, included in Publication 1244. In addition to the information asked for on Form 4070A, you also need to keep a record of the date and value of any noncash tips you get, such as tickets, passes, or other items of value. Although you do not report these tips to your employer, you must report them on your tax return.
Report tips to the employer, unless less than $20
The Internal Revenue Code requires employees to report to their employer in a written statement, all cash tips received except for the tips from any month that do not total at least $20. Cash tips include tips received from customers, charged tips (e.g., credit and debit card charges) distributed to the employee by his or her employer, and tips received from other employees under any tip-sharing arrangement. No particular form must be used. The statement must be signed by the employee and must include:
- Employee’s name, address, and social security number,
- Employer’s name and address (establishment name if different),
- Month or period the report covers, and
- Total of tips received during the month or period.
The employee may use Form 4070, Employee’s Report of Tips to Employer, (available only in Pub. 1244, Employee’s Daily Record of Tips and Report to Employer), unless some other form is provided by the employer. You can use an electronic system provided by your employer to report your tips.
Both directly and indirectly tipped employees must report tips to the employer.
Report all tips on an individual income tax return
An employee must use Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to report the amount of any unreported tip income to include as additional wages on their Form 1040, U.S. Individual Income Tax Return, and the employee share of social security and Medicare tax owed on those tips.
When to Report Tips to Your Employer
Employees must report tips to the employer by the 10th of the month after the month the tips are received. For example, tips received by an employee in August 2023 are required to be reported by the employee to the employer on or before September 10, 2023. If the 10th falls on a Saturday, Sunday, or legal holiday, an employee may give the report to the employer by the next day that is not a Saturday, Sunday, or legal holiday. An employer may require employees to report tips more than once a month. However, the statement cannot cover a period of more than 1 calendar month.
Do Not Include Service Charges in Your Daily Tip Record
Charges added to a customer’s check, such as for large parties, by your employer and distributed to you should not be added to your daily tip record. These additional charges your employer adds to a customer’s bill do not constitute tips; they are service charges. These distributed payments are non-tip wages, and are subject to social security tax, Medicare tax, and federal income tax withholding.
An employer’s or employee’s characterization of a payment as a “tip” is not determinative. Distributed service charges (often referred to as “auto-gratuities” by service industries) should be characterized as non-tip wages. Revenue Ruling 2012-18reaffirms the factors which are used to determine whether payments constitute tips or service charges. Q&A 1 of Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:
- The payment must be made free from compulsion;
- The customer must have the unrestricted right to determine the amount;
- The payment should not be the subject of negotiation or dictated by employer policy; and,
- Generally, the customer has the right to determine who receives the payment.
See example below.
Example: Restaurant’s menu specifies that an 18% charge will be added to all bills for parties of 6 or more customers. Dana’s bill for food and beverages for her party of 8 includes an amount on the “tip line” equal to 18% of the price for food and beverages and the total includes this amount. Restaurant distributes this amount to the waitresses and bussers. Under these circumstances, Dana did not have the unrestricted right to determine the amount of the payment because it was dictated by employer policy. Dana did not make the payment free from compulsion. The 18% charge is not a tip. Instead, the amount included on the tip line is a service charge dictated by Restaurant.
Reporting Tips Allocated by Your Employer
If the total tips reported by all employees at a large food or beverage establishment are less than 8 percent of the gross receipts (or a lower rate approved by the IRS), the employer must allocate the difference among the employees who receive tips. If your employer allocated tips to you, they are shown separately in Box 8 of your Form W-2. They are not included in Box 1 (Wages, tips, other compensation), Box 5 (Medicare wages and tips), or Box 7 (Social security tips) of your Form W-2, Wage and Tax Statement. Generally, you must report the tips allocated to you by your employer on your income tax return. Attach Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to Form 1040, U.S. Individual Income Tax Return, to report tips allocated by your employer (in Box 8 of Form W-2). Other tips not reported to the employer must also be reported on Form 4137. However, you do not need to report tips allocated to you by your employer on your federal income tax return if you have adequate records to show that you received less tips in the year than the allocated amount.