MONEY MANAGEMENT

TIPS AND TAXES: WHAT YOU NEED TO KNOW

(February 1, 2007) -- What do waiters and waitresses, taxi and limo drivers, and hairdressers and spa workers have in common? They are all service industry workers who derive a significant portion of their income from tips. Those tips must be reported to the Internal Revenue Service (IRS). Here, the Virginia Society of CPAs offers its own “tips” concerning the rules governing how to report tip income.

Keep a daily record of tips

The IRS requires employees who receive tips to keep a daily tip diary or to use some other method to record tip earnings. These records must show how much you were paid directly in cash tips and how much you received from your employer in credit card tips. You must also record tips you received through tip-sharing arrangements and the amounts you “tipped out” to other workers.

One way to document your tips is to use IRS Form 4070A, Employee's Daily Record of Tips, as your personal tip diary. If you are audited, this can help verify your tip income.

Report tips to your employer

Anyone who receives $20 or more in tips during the month must report to his or her employer the total amount of tips received by the 10th day of the following month. If the 10th falls on a weekend or holiday, the information is due on the next business day.

This reporting requirement applies equally to employees who are tipped directly from customers, such as restaurant servers and hairdressers, and to those who are tipped indirectly, such as bus boys. When reporting your monthly tips, you must provide your employer with your name, address, Social Security Number, employer’s name and address, the month for which you are reporting, and the amount of tips you received.

Your employer uses the amount of tip income you report to determine how much income tax withholding to deduct from your paycheck. The tip amount you report also determines how much your employer pays into your Social Security and Medicare accounts. This, in turn, affects the Social Security and Medicare benefits you and your family qualify for when you retire, become disabled or die.

Protect yourself from allocated tips

It’s especially important for individuals who work in large food or beverage establishments to keep accurate tip records. That’s because some restaurants allocate to each employee an estimated amount of tips. Tip allocation is required by the IRS when the total amount of tips employees report to the restaurant during a given period falls below a required minimum percentage of gross sales.

As a general rule, if your Form W-2 shows allocated tips, you must report this amount as income unless you have a daily tip record documenting the amount of tips you actually received. If you do, you can claim as income only the amount of tips you actually received.

Report all tips on your income tax return

All tips — even those that you are not required to report to your employer because the total for the month is less than $20 — are still taxable and must be reported on your tax return. The same holds true for
non-cash tips, such as tickets, passes or other items of value.

Work with a CPA

The IRS has a number of programs in place to ensure that tip income is reported. If you’re unsure of your tip reporting obligations, meeting with a CPA can help ensure you comply with IRS requirements.

The Virginia Society of CPAs is the leading professional association dedicated to enhancing the success of all CPAs and their profession by communicating information and vision, promoting professionalism, and advocating members’ interests. Founded in 1909, the Society has nearly 8,000 members who work in public accounting, industry, government and education. This Money Management column and other financial news articles can be found in the Press Room on the VSCPA Web site at www.vscpa.com.