Internal Revenue Code tax tips same way it treats any other income under the principle that all receipts are income unless clearly provided that an income is not taxable. Tips receipts by employee are taxable income under IRC . US tax law requires that employers in certain sectors like food and restaurant , bars, casino where it is custom to tip the employee to submit an annual report about the tips . From the information out of such report , IRS can compare the tips reported in the W2 to find out unreported tips . Therefore , it is legally important to tell the employer about the tips received by the employee. Please note that not only the tip receipt is taxable income , it is also subject to Social Security and Medicare tax withholding. So, every time one under reports , he/she also prevents unlawfully withholding tax on such income .
Here are most common questions answered related to taxation of tips income .
When to report tip income ?
Internal Revenue Code provides that any employee who receives at least $20 in tips in a month , must to report tips to their employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give your employer the report by the next day that is not a Saturday, Sunday, or legal holiday.
Does my employer files any report about tip income to IRS ?
The law assumes an average tip rate of 8% for industry in which tips are customary .Further, employers of that sectors (say restaurants and bars) are required to to file Annual Information Return of Tip Income and Allocated Tips in Form 8027 if it employed more than 10 employees whose combined hours exceeded 80 on a typical business day in 2016 . The due date for filing form 8027 falls at the end of February 2016 for employers who file in paper format, and a month later for employers who file electronically.
From this annual return of tips, IRS will find out the average tips you might have earned . They will ask you several questions if they find out big gap between the tips reported by employer and the tips reported in employee tax form W2 Box 7 (Social Security tips). for you.
Do I Need to Maintain Records of Tips ?
Yes, the law require you to keep a record of tips . That you can do in two ways-
- Either use a pro-forma tip diary in Form 4070A . Employee’s Daily Record of Tips and Report to Employer. Pub. 1244 is also available at www.irs.gov/pub1244. Pub. 1244
- You can note down daily record with yourself
the Federal Law provides that you should keep the record for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return.
What to do if I Unreported the Tax Tips to my Employer ?
Two steps must be taken by you , in case the tips received by you were not reported to the employer and you find that the W2 issued by the employer also report in Box 8 , the difference between the average rate of tips ( 8% usually) and tips reported by you .
(i) Use form 4137 to pay Social Security and Medicare taxes on all tips which were allocated and unreported tips.
(ii) When filing tax return, add the allocated and unreported tips as income .
Is there a penalty for non-reporting of tips income ?
Yes, Internal Revenue Code provides for a penalty equal to 50% of the social security, Medicare, Additional Medicare, or railroad retirement taxes you owe on the unreported tips. The penalty amount is in addition to the tips tax you owe. But , it must be noted that , as is case with all penalty , you can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, attach a statement to your return explaining why you did not report them.