Receiving Tips Can Be Taxing
Article Highlights:
- Collecting Tips
- Tip Splitting
- Service Charges
- Record Keeping
- Employer Reporting
- Allocated Tips
Tips are amounts freely given by a customer to a person providing a service. They are generally given as cash but also include tips made on a credit or debit card or as part of a tip-sharing arrangement. Tips can also be in the form of non-traditional gifts such as tickets to events, wine, and other items of value. If you receive $20 or more in tips in any month, you should report all of your tips to your employer, with these exceptions:
- Tip-splitting – Tips you give to others under a tip-splitting arrangement are not subject to the reporting requirement by you (the employee initially receiving them). You should report only the net tips you received to your employer.
- Service (cover) charges – These are charges arbitrarily added by the business establishment (employer) – for example, a specific percentage of the bill for parties exceeding X in number – and are excluded from the tip-reporting requirements. If your employer collects service charges from customers, your share of these charges, as determined by your employer, is taxable to you and should already be included as part of your wages.
Report tips to your employer – If you receive $20 or more in tips in any month, you should report all of your tips to your employer. Your employer is required to withhold federal income, Social Security, and Medicare taxes. State taxes may have to be withheld as well. If the tips received are less than $20 in any month, don’t think you are off the hook; although they need not be reported to the employer, these tips are still taxable and must be reported on your tax return, as they are subject to income, Medicare, and Social Security taxes.
Employer allocation of tips – If you work for a large restaurant, you may find tips you didn’t know about on your W-2 form. Restaurants with a large serving staff report a total called "allocated tips" to the IRS. Here is what allocated tips are all about:
If this situation applies to you, the allocation amount will be noted in a separate box on your W-2, and these allocated tips won’t be included in the total wages shown on your W-2 form. You will need to report the allocated tip amount as additional income on your tax return unless you have adequate records to show that the amount is incorrect. The IRS frequently issues inquiries if the taxpayer’s W-2 shows an allocation of tips and a lesser amount is reported on his or her tax return.
Self-Employed Individuals – If you are self-employed, you don’t have an employer to report tips to, and you simply include the tips you received in your self-employed income on your tax return for the year when you received the tips.
Because they are usually paid in cash, tips are a frequent audit item. If you are receiving tips and have any questions about their taxability, please give this office a call.
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Frequently Asked Questions
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You can prepare your taxes yourself, especially if your business is simple.
But once you have contractors, employees, business loans, equipment purchases, mileage, mixed expenses, or growing revenue, things get more complex. At that point, tax preparation becomes a way to make sure your business is reported correctly, your deductions are handled properly, and your records can support what you file.
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Send anything that shows what your business earned, spent, bought, paid, borrowed, or changed during the year.
That usually means your income records, bank statements, credit card statements, payroll reports, contractor payments, loan documents, mileage records, and prior-year tax return. Also tell me about anything unusual, such as buying a vehicle, hiring someone, opening a new location, or taking out a business loan.
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Messy books can slow things down. If expenses are in the wrong categories, transactions are missing, or personal and business spending are mixed together, your tax return may not show the right profit. We may need to clean things up before filing, so your return is accurate and easier to support.
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Possibly, if it was truly for your business and you have proof.
Still, it is much better to avoid this when you can. A separate business bank account and business credit card make everything cleaner. They save time, reduce confusion, and make your records much easier to defend if anyone ever asks questions.
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Most small business owners can deduct ordinary business expenses like software, advertising, supplies, insurance, rent, payroll, contractor payments, professional fees, travel, and some vehicle costs.
The question I usually ask is simple. Was this expense clearly for the business? If yes, we can look at how it should be handled. Personal expenses should stay personal.
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