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Don't get tripped up by tip income

Workers who depend on tips to boost their incomes know these extra dollars can make a big difference. The Internal Revenue Service thinks so, too.

Tips are taxable income and must be reported to the IRS. The agency has a system in place to collect this information from the employers of people who get a salary and who also commonly get tips as part of their jobs. By the 10th of each month, if employees earned tips of more than $20 for the previous month, they must tell their bosses just how much extra cash they pocketed.

This includes cash tips, as well as amounts added to credit cards and any money employees share.

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How tips add up
The employer takes the reported tip amount, adds it to the worker's base pay amount and then figures the appropriate amount of income tax to withhold from the employee's paycheck. Tip earners should keep a running daily log of this money. A tip worksheet is available in IRS Publication 1244, Employee's Daily Record of Tips and Report of Tips to Employer.

What about those occasional months when customers aren't feeling very generous and you don't make enough tips to alert the boss? Sorry, but you're not off the tax hook. All tips, even those amounts that fall under the $20 reporting limit, still are taxable. The IRS expects you to own up to them when you fill out your annual tax return.

And if you work for a large restaurant, you may find when you get your W-2 form that you got tips you didn't know about. Restaurants with a large serving staff report a total called "allocated tips" to the IRS. In essence, this is what your boss thinks you should have made in tips.

This system was designed to ensure that the IRS is informed of what it considers reasonable tip income for all eligible employees, regardless of whether they actually got any tips. Good recordkeeping can save you some tax dollars in this situation. If you kept a complete, detailed daily tip record showing your actual amount of tips, you don't have to report allocated tips.

Reporting tips as income also could pay off in later years. In addition to counting toward income tax, tips also are used to figure out how much should be paid into a worker's Social Security and Medicare accounts. This will make a difference when your are eligible to collect these benefits at retirement, if you are disabled or if your family seeks survivor benefits.

Not just for waiters
Finally, don't think you can avoid tip reporting because you don't work for a restaurant.

Anyone who gets a salary or wages and collects tips -- cab drivers, hairdressers, club attendants, performers -- must report these payments as income. (If you don't get a salary and work only for tips, that's technically self-employment income. You won't have a boss to tell the IRS about your tips, but the tax collector still expects you to report them.)

Details on the IRS requirements of workers who depend on tips can be found in IRS Publication 531, Reporting Tip Income.

And workers who live in a state with a personal income tax need to let that tax collector in on their tip money, too.

-- Updated: Jan. 15, 2003

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See Also
Today's Tax Tip Archive
Hot tip to avoid an audit: Report all your tip income
Tax Basics: taxable income
More tax stories

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