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.
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.
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.
So how do you keep the IRS out of your tip jar? First and foremost, follow the reporting requirements.
It doesn’t matter what your annual salary is. If you received tips totaling more than $20 in a month, report the amount to your boss by the 10th of the following month. Of course, if the 10th is a weekend day or holiday, you have until the next business day to report it.
The IRS doesn’t care how you track your tip amounts, but any time you deal with tax reporting it’s a good idea to have as complete and accurate records as possible. An easy way to document your tip information is to use the paperwork — Form 4070A and Form 4070 — that the IRS has created. Both forms are part of a booklet called Publication 1244.
Form 4070A is a log so you can keep daily track of your tips. You don’t have to file it with your boss or the IRS, but it’s a quick way to accurately record the tips. And if the IRS ever questions you, it’s a supporting document for your case.
After you’ve added up all your tips and they are (let’s hope) more than $20, let your boss know the amount. You need to provide your name, address, Social Security number, your employer’s name or business name and address, the month for which you got tips and the total you received. This can all be entered on Form 4070.
If you work for a large restaurant, you may find when you get your W-2 form at the end of the year that you got tips you didn’t know about. How can this be?
Thank — or blame — your co-workers.
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.
How are these “reasonable” tips figured? Your boss takes a percentage, usually 8 percent but no less than 2 percent, of his restaurant’s overall food and drink sales and subtracts from that the total of all the tips you and your co-workers report for the month. The result is what is believed to be unreported tips and is parceled out to employees as allocated tips. It’s up to your boss to decide how to attribute these tips to each employee, for example, by giving each of you a portion based on how long your shift is.
If all employees are reporting their tips in full and on time, there is no need for a restaurant to allocate tips. But if your buddy decides he’s only reporting $50 of the $120 tip he got on a $600 meal for the group at the back table, the restaurant owner likely will presume the tip was underreported. That triggers the computing of allocated tips for all employees.
Your good recordkeeping can help you out, though. There are two cases where you don’t have to report allocate tips as income:
- You kept a complete, detailed daily tip record showing your actual amount of tips.
- You skipped a couple of tip notations in your daily log, but your record still reveals the actual tips you earned were more than the combined total of what your employer’s records show and the allocated tip amount on your W-2.
If you don’t have the records and must report the allocated tips, add the W-2’s box 8 amount to the salary and wages shown in box 1 and report it all as income on line 7 of your Form 1040.
You do have to use Form 1040 instead of the other two, less-complicated forms. This is because Social Security and Medicare taxes weren’t withheld from allocated tips, and these taxes now must be figured separately on your return. You can figure the amount using Form 4137.
You’ll also need this form if you were out sick on the 10th one month and didn’t report your tips to your employer. There’s also a line for entering the tips that you didn’t have to file with your boss because the monthly total was less than $20. Even though these smaller amounts aren’t reportable to your employer, Social Security and Medicare taxes are due on any tips, regardless of how small the amount.
By transferring the data on your W-2 to Form 4137, you’ll determine how much of your tips were not subject to Social Security and Medicare taxes and compute the amount due for them. This amount of tax is entered on your Form 1040 (line 58 for the 2008 version). This helps ensure that you get appropriate credit so you’ll get more Social Security money when you retire.
So good luck on your new job. Keep smiling, serve the coffee hot and salads cold, and you’ll be sure to get a fat tip. And by keeping track of and reporting those gratuities, you’ll avoid having to serve up a tray full of answers at tax time to the IRS.