Employees who receive tips as a portion of their earnings should maintain adequate records in order to report the income for tax purposes. For many service workers, tip income is likely to exceed their hourly wage rate. Tipped employees can better prepare for tax preparation by understanding the nuances of reporting tip income.

The federal minimum wage for tipped workers is $2.13 per hour. Although many states have laws that provide higher hourly wages, gratuities still comprise a significant portion of income for tipped workers. Wages earned at the hourly rate are subject to tax withholding in the same manner as any other employee. In contrast, tax from tip income is withheld only after you have reported the tips to your employer.

Keep good records

Maintaining a record of tips received each day is essential. For any month in which you receive a total of over $20 in tips, you should report the amount to your employer. The reported tip income is used by your employer to withhold income tax, Social Security tax, and Medicare.

Each monthly summary should be presented to your employer by the 10th day of the following month. If the 10th day is a weekend day or an official holiday, present the report by the next day that is not a weekend day or official holiday. Ideally, the taxes withheld by your employer throughout the year will roughly equal the tax amount calculated on your income tax return.

Reconcile employer W-2

As a tipped worker, IRS Form W-2 received from your employer at the end of the year may include an entry labeled as allocated tips. An amount shown as allocated tips is not necessarily taxable. If your Form W-2 includes an entry for allocated tips, your tax preparer will need to reconcile the amount with your tip records.

Certain types of businesses must allocate tips to employees if the amount of reported tips at the establishment falls below a designated percentage of sales. If your records indicate that you actually received less than the allocated amount, you can rely on your own records for calculating total taxable tips.

Complete Form 4137 if needed

If there is additional tip income to include, it is reported on IRS Form 4137. Form 4137 is used to calculate Social Security and Medicare tax on unreported tips, as well as to add the unreported tips as taxable income. Form 4137 supports your IRS Form 1040.

An additional penalty can be assessed for 50 percent of the Social Security and Medicare tax paid late with Form 4137. The penalty can be waived by attaching a statement to your tax return briefly explaining why tips were not timely reported. Contact your accountant (like those at Knowledge Integration Solutions) for assistance in reporting tip income or any other aspect of tax preparation.    

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