Individuals who perform services in certain industries receive tips as part of their compensation for the services they provide. Businesses where individuals commonly receive tips are restaurants, hotels, and salons. For individuals who work in these types of businesses, tips usually make up a large part of their pay. (FS-2022-37)
What are tips?
Tips are optional payments that customers usually make to employees who perform services in a business where tips are customary.
Tips can be cash or noncash.
- Cash tips include those received directly from customers, electronically paid tips distributed to the employee by their employer and tips received from other employees under any tip-sharing arrangement. Generally, workers must report cash tips to their employer.
- Noncash tips are items of value provided to a worker in any medium other than cash. Noncash tips can include items as tickets, passes or other goods or commodities that a customer gives the employee. Workers don’t have to report noncash tips their employer.
For tax purposes, four factors determine whether a payment qualifies as a tip. Normally, all the following four factors must apply:
- The customer makes the payment voluntarily (i.e., free from compulsion);
- The customer must have the unrestricted right to determine the amount;
- The payment is not negotiated with or dictated by employer policy; and
- Generally, the customer has the right to determine who receives the payment.
Tips can also be direct or indirect.
A direct tip occurs when an employee receives the tip directly from a customer, even if it is part of a tip pool. Examples of directly tipped employees include waiters, waitresses, bartenders, and hairstylists.
An indirect tip occurs when an employee, who normally does not receive tips directly from customers, receives a tip. Examples of indirectly tipped employees include bussers, service bartenders, cooks, and salon shampooers.
Daily tip record.
Tipped workers must keep a daily record of the cash tips they receive. Tipped workers can use Form 4070A, Employee’s Daily Record of Tips, which can be found in Publication 1244, Employee’s Daily Record of Tips and Report of Tips to Employer, to keep track of the cash tips they receive.
Tipped workers should also keep a record of the date and value of any noncash tips. Although the IRS doesn’t require workers to report noncash tips to their employer, noncash tips must be reported as income on the worker’s tax return.
How to report tips to your employer.
Employees must report tips to their employer by the 10th of the month following the month the tips were received. The IRS doesn’t require a worker to use a particular form to report their tips. However, a worker’s tip report generally should include:
- Employee signature;
- Employee’s name, address and social security number;
- Employer’s name and address (and business name if different);
- Month or period the report covers; and
- Total of tips received during the month or period.
Whatever method or system the employee uses to report tips, it must contain the above information.
Note. Employees whose tips are less than $20 per month don’t need to report them to their employer but must include them as income on their tax return.
How to report tips on a tax return.
Employees should receive from their employer a Form W-2, Wage and Tax Statement, that includes their reported tips. Any tips an employee didn’t report to their employer should be reported on their tax return as additional wages.
Employees with unreported tips (i.e., tips not reported to their employer) should use Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to report their tips to the IRS.
Note. The employee is liable for the employee’s share of Social Security and Medicare tax on tips they don’t report to their employer.
Employer requirements.
Employers with tipped employees are required to:
- Keep their employees’ tip reports.
- Withhold taxes, including income taxes and the employee’s share of Social Security tax and Medicare tax, based upon employee’s wages and reported tip income.
- Pay the employer share of Social Security and Medicare taxes based on the total wages paid to tipped employees as well as the reported tip income.
- Report this information to the IRS on Form 941, Employer’s Quarterly Federal Tax Return.
- Deposit the withheld taxes in accordance with federal tax deposit requirements.
For more information about employee’s reporting of tips to their employer, see Checkpoint’s Federal Tax Coordinator ¶ H-4344.
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