Yes, tips are taxable income. But that’s not necessarily bad news, as I’ll explain below. First, here is some information from the IRS about reporting tip income:
If you work in an occupation where tips are part of your total compensation, you need to be aware of several facts relating to your federal income taxes. Here are four things the IRS wants you to know about tip income:
1. Tips are taxable. Tips are subject to federal income, Social Security and Medicare taxes. The value of non–cash tips, such as tickets, passes or other items of value, is also income and subject to tax.
2. Include tips on your tax return. You must include in gross income all cash tips you receive directly from customers, tips added to credit cards, and your share of any tips you receive under a tip–splitting arrangement with fellow employees.
3. Report tips to your employer. If you receive $20 or more in tips in any one month, you should report all of your tips to your employer. Your employer is required to withhold federal income, Social Security and Medicare taxes.
4. Keep a running daily log of your tip income. You can use IRS Publication 1244, Employee’s Daily Record of Tips and Report to Employer, to record your tip income.
Many employees who receive tip income think they’re better off if they don’t report tips. Obviously, the fact this is illegal should be reason enough to report tips. But the truth is, it’s often in the best interest of a tipped employee to report the income, for several reason.
First, many employees who receive tips do not make enough money to have any tax liability, even with the tips. However, the extra income may increase the amount of money the taxpayer receives as a result of Earned Income Credit, especially if the taxpayer has any qualifying dependents. As a result, just from a tax perspective, the employee might be better off, or at least no worse off, as a result of reporting tips.
Second, employees who receive tips often do not have a lot of job security, and may receive unemployment as a significant source of income. Unemployment compensation is calculated based on earnings, and the more you earn, the more unemployment you are eligible to receive. So having higher earnings will increase your unemployment compensation if you experience a period of unemployment. In addition, if the employee becomes disabled and unable to work, once again the amount of disability pay an employee is eligible to receive is based on earnings.
Finally, higher income increases eligibility for loans. If you need to take out a loan for a car or a house–or an emergency–a bank will want to see proof of income. (Not too long ago this stopped being the case…but after the financial crisis banks are once again requiring proof of income.) This proof of income comes from pay-stubs and filed tax returns. So reporting this income will make it easier to borrow money if the need arises.
Sure, it’s entirely possible that reporting tips will make you worse off financially. But of course it’s something that must be done because it’s simply the law. Hopefully you can feel a little better about it knowing that you may very well benefit from reporting those tips.