Planning on getting a job at the local steakhouse to earn a little extra spending money? Here's a tax tip hot off the grill: Report all the gratuities you receive or the tax collector could come looking for you.
If you earn more than $20 a month in tips, tax laws require you to tell your employer the amount by the 10th of the following month. Bankrate's Tax Guide Calendar can help you keep track of your tip reporting responsibilities.
For restaurant employees, tips include cash left at the table, amounts added to credit card charges, tips you got from your boss as part of a tip-pooling arrangement and money you received from a co-worker if you shared the serving work.
Tip reporting isn't limited to restaurant employees. Anyone who gets a salary or wages and collects tips -- cab drivers, hairdressers, club attendants, performers -- must report tips as income. Your employer uses the tip income you report to figure out how much payroll withholding, Social Security and Medicare taxes to take out of your regular paycheck.
And don't think you're off the tax hook if your customers turn out to be penny pinchers one month. All tips, even those amounts that fall under the $20 reporting limit, still are taxable. The Internal Revenue Service expects you to own up to them when you fill out your annual tax return.
Reporting tip income
The requirement to report tip income isn't just for restaurant employees. And there's no threshold amount you have to reach, either.
On the fast TRAC
Because tipping waiters is second nature for most of us, the IRS takes a long, hard look at the food service industry when it comes to tip income. The agency believes that only a fraction of tips are ever reported by servers. To collect more of that suspected lost money, the Tip Reporting Alternative Commitment program was established.
Called TRAC for short, the program is a voluntary tax collecting arrangement between the IRS and restaurants. Under the program, restaurants educate employees about their tip reporting responsibilities and set up systems for reporting, maintaining and making tip records available to the IRS.
But TRAC is only one of several voluntary tip reporting programs for food industry employers. Additional reporting options for restaurant workers also can be found in IRS Publication 1875. And similar IRS programs are available for other businesses whose workers are routinely tipped.
Many restaurants participate in TRAC because it protects them from "employer-only" tip audits. This means the IRS will not assess a business for its portion of Social Security and Medicare (FICA) taxes on workers' tips unless the agency first examines the records of employees suspected of not reporting income.
Where a business does not sign a TRAC agreement, the IRS says it has the right to look at a firm's records and bill the company for taxes on unreported tips without ever inspecting individual employees' tax data.
The agency got a boost in its tip-collection efforts in June 2002, when the Supreme Court ruled the IRS can take a look at a restaurant's records, come up with a total amount of tips it thinks employees should have reported and bill the restaurant for its share of taxes on any suspected unreported tips. The court decision means the IRS doesn't have to examine individual employees' records or credit employer FICA payments to individual Social Security accounts.
Tip scofflaws, beware With the IRS now looking for ways to close the so-called tax gap -- that's money the agency says is owed to Uncle Sam but is not paid -- restaurant employees shouldn't be surprised if they get more pressure from their bosses to accurately report tips.
While the National Restaurant Association, the industry group that led the fight against the employer-only approach, has consistently decried being forced into the role of "tip police," the group acknowledges that TRAC is "the best protection an operator has."
Even the IRS agrees -- to a point. Thomas Burger, a former IRS chief of employment taxes, acknowledged that "the real fault is not the employer's. It's the employees who are not reporting."
Too many people who receive tips, he added, view them as nontaxable gifts for a job well done. The IRS and restaurateurs will continue their efforts to educate employees that all tips are indeed taxable income.
And while it may be harder to catch individual tip scofflaws rather than simply punishing their employers, that won't stop the IRS from trying. For example, because TRAC requires restaurants to file annual reports of gross receipts and tip receipts, the IRS can compare a restaurant's income with the reported percentage of tips by each of its employees. A large discrepancy probably would raise a few tax examiner eyebrows.