Tip Income: Maintaining Proper Records

Aug 04, 2015

In a recent tax court case, the IRS challenged a bartender’s income-tax return, arguing that he had made substantially more in tip income than he had reported. The judge ruled in favor of the bartender, finding that the bartender’s daily tip diary was more reliable than the IRS’s estimates. Like the bartender, all taxpayers who earn tip income need to maintain proper records.

Three General Rules

Tips are subject to both income and employment (Social Security and Medicare) taxes. To report their tips correctly, employees need to:

  1. Keep a daily tip record
  2. Report tips to their employers in a timely manner
  3. Report all tips on their income-tax returns

Keeping Records

reporting_tipsTo record daily tips, employees can either keep a tip diary or retain copies of relevant documents, such as restaurant bills and charge slips. The IRS has provided a convenient tip diary (Form 4070A) in Publication 1244, which can be downloaded from www.irs.gov. Alternatively, employers may provide an electronic form for recording daily tips — employees should just be sure to retain paper backups.

Employee records should include the following information:

  • Employee name and address
  • Name of the employer/establishment
  • Amount of both cash tips and charge/debit card tips received from customers and/or from other employees through a tip-sharing arrangement
  • Amount paid out each day to other employees through a tip-sharing arrangement and the names of those employees
  • Date each entry was made

Reporting to the Employer

Additionally, employees must make timely reports of their tip income to their employer. For any month an employee has $20 or more in tips (both cash and debit/credit card charges), the employee must report the amount by the 10th day of the following month.

Reporting on the Tax Return

Employers report both wages and reported tip income in Box 1 of a tipped employee’s W-2. The employee reports this amount on his or her tax return. Employees also are required to report any additional tips not already reported to their employers during the year.

Employer/IRS Tip Reporting Programs

Tipped employees may want to check with their employers to see whether they participate in one of the IRS’s tip reporting compliance programs. One such program is the Tip Rate Determination/Education Program (TRD/EP). Under the program, an employer can enter into a Tip Reporting Alternative Commitment (TRAC), which allows it to establish specific procedures for tip reporting. In return, the IRS agrees not to challenge employers or employees who are in compliance.

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