Are Tips Taxable Income? How To Calculate, Track And Report Tips

The IRS considers tips to be taxable income, whether they’re received as cash, gift cards or physical gifts. Employees receiving tips are required to report them to their employer and must pay federal income tax on tipped earnings of $20 or more per month. For earnings exceeding $20 in a month, employees are required to claim 100% of their income from tips.

So, how do you ensure you’re tracking and reporting tips to the IRS correctly?

Why Are Tips Taxed?

The IRS taxes tips because they are considered income that should be reported and taxed similarly to wage earnings. Employees are required to keep records and report tip income of over $20 per month to their employer. Reporting tips as income ensures that all sources of income are accounted for and taxed, contributing to the overall tax base and fair distribution of taxes.

Which Tips Are Taxable?

According to the IRS, tips are “discretionary payments determined by a customer that employees receive from customers.” Essentially, anything a customer voluntarily gives you should be counted as a tip.

Although service fees are not considered tips, your employer includes them in your paycheck and they are subject to income, Medicare, and Social Security taxes. You are only responsible for recording and paying taxes on the portion you receive from tip pools, not the total amount in the pool.

How To Calculate Taxes On Tips

Your employer is required to withhold taxes on both your tips and wages. The first step is to keep accurate records of your tips.

Then, the easiest way to determine your taxes on tips is by using an online calculator. Simply plug the values into the fields to assess your local, state, federal, Social Security and Medicare tax withholdings. These amounts will vary depending on your income, filing status, number of dependents, location, and pretax and post-tax deductions.

How To Track Your Tips Throughout The Year

The IRS states, “Employees must keep a daily record of the cash tips they receive.” There are several ways to do this.

• Use Rocket Money^SM to log your income: You can easily use Rocket Money to track your tips (and much more) by visiting the Transactions tab, and clicking the “+” sign on the top left of the app to add tip income. 
• Keep a written log or journal: Update the log every day you earn tips, and keep the tally in a safe place.
• Use a digital spreadsheet: Enter your tip income on a phone or computer immediately after you leave work.
• Log tips on IRS Form 4070A: This voluntary form is useful for recording tips and has columns for cash tips, credit card tips, and money paid out to other staff.

Creating a simple system and then updating it on the days you work is critical for accurately recording your tips. You can then use this information to report your monthly tips to your employer.

How To Report Tips To The IRS

It’s also important to report your tip income to your employer every month by the 10th of the following month. Your employer needs this information to adjust your withholding correctly. If they do not have a process for reporting tip income, you can also use IRS Form 4070.

Keep in mind that the payroll tracking system should report tips left on a debit or credit card. But you are responsible for reporting cash and other tips to your employer.

At the end of the year, you’ll need to report your tips on your income tax return. This will be easy if you regularly report your tip income to your employer. All your income, wages and tips should be included in your W-2. If you have unreported tips for the year, then you’ll need to file an IRS Form 4137 at tax time.

What Happens If You Don’t Report Your Tips To The IRS?

Although it might be tempting not to track and report your tips, there are some major potential consequences. The IRS may audit your tax return if they suspect you aren’t reporting your tips. An audit can be a long and stressful process that is best to avoid. If an audit reveals that you’ve underreported your tip income, you could face financial penalties of up to 50% of the Medicare and Social Security taxes you owe on unreported tips. 

Even if you avoid an audit, underreporting your income can lead to long-term impacts on Social Security benefits at retirement. Although your employer is responsible for paying a share of your social security taxes on reported tips, they aren’t responsible for this for unreported tip income. Therefore, you won’t receive as much Social Security that would otherwise be due to you.

Finally, underreporting your income could have a negative impact on your finances if the IRS levies penalties.

Tips For Paying Taxes On Tips

Keep the following information in mind regarding taxes on your tip income:

• Track your tip income carefully: It is your responsibility to keep accurate records of all your cash tips, but your employer should track electronic tips.
• The IRS taxes tips: You must pay income, Social Security and Medicare taxes on your tips and wages, including cash tips.
• Don’t report any tip totals under $20 in a month: The IRS doesn’t require you to report tip income of less than $20 a month per job.
• Report your tips to your employer by the 10th of each month: The IRS requires you to report your tips monthly to your employer, and you have until the 10th of the following month.
• Report your tips again on your income tax return: Tips of over $20 a month are considered taxable income and must appear on your tax return.
• Catch up on unreported tips: If you didn’t report all your tips, you can complete Form 4137 to determine the Social Security and Medicare taxes you owe.
• Report only the tips you keep: If you pool your tips with other employees, you only need to pay taxes on the tips you keep.

Taxable Tips FAQs

How does the IRS keep track of cash tips?

Employees are responsible for tallying cash tips of $20 or more a month and reporting them to their employer. The IRS requires employees to provide the following information in their monthly tip statement:

• Their name, address and Social Security number
• The employer's name and address
• Time period covered by the report
• Total of tips received during that time
• The employee’s signature

The employer then includes the cash tips in the employee’s W-2 for a given tax year in Boxes 1, 5 and 7.

Do I need to pay taxes on service fees?

Some businesses charge fees to customers, such as automatic gratuity for large parties, bottle fees, room service charges or delivery fees. Although you do not have to report this as tip income, this money is still subject to taxes. Your employer should include these fees in your paycheck, which is part of your taxable income.

What types of jobs pay tips?

Many employees in the service industry can earn tips, including servers, bartenders, baristas, delivery drivers, barbers, hair stylists, manicurists, babysitters, dog walkers, taxi or ride-share drivers, tour guides, cleaners, concierges, house movers, porters, golf caddies, tattoo artists and casino dealers. However, tips are much less common for jobs outside the service industry.

How do I pay taxes on pooled tips?

Some employees pool their tips and split them with coworkers, but you only need to pay taxes on the tips you actually keep. Let’s say you got $200 in tips, but shared $50 with the bartender, then you only need to report $150 in tips to your employer.

Will my tip income appear on my W-2?

All tips you reported to your employer should be included along with your wages in your W-2 because they are part of your income.

Tip income should be included in your W-2 in:

• Box 1 - wages, tips, and other compensation
• Box 5 - Medicare wages and tips
• Box 7 - Social Security tips

However, if you don’t report all your cash tips to your employer each month, the tips will not appear on your W-2. In this case, complete Form 4173 for tips not reported to your employer.

The Bottom Line: Tips Are Taxable Income

If you receive tips at work, it’s important to understand how to properly tally them for tax purposes. The IRS considers tips taxable income, and it’s essential to report your cash tips totaling $20 or more monthly to your employer. This will help ensure that your W-2 has all your income, both tips and wages.

You can use Rocket Money to easily record your tips and other income. Sign up with Rocket Money to get started.