What Percentage of Tips Have To Be Claimed for Income Taxes?
When you're in a tipping industry, keeping track of the tips you receive is paramount, especially when it comes time to report those earnings.
Dec. 29 2021, Published 5:09 a.m. ET
Perhaps one of the most stressful obligations is reporting taxes. In 2018, 80 percent of filers made a mistake when filing their tax returns. Some of those people failed to report tips or made calculation errors.
Taxes are considered a form of income, whether they're cash or not. When you files taxes, how do you report tips and what percentage needs to be claimed?
What's considered a tip?
The IRS defines tips as “discretionary (optional or extra) payments determined by a customer that employees receive from customers.” Tips can include direct cash from customers, tips through an electronic payment such as a credit, debit, or gift card. Any other electronic payment that provides a payment may be considered a tip. The value of any item (non-cash) or tips from a tip pool can be considered a tip, whether formal or informal.
The IRS requires that those who work in a tipping environment keep a tip record. To keep a tip record, employees can use Form 4070A, Employee’s Daily Record of Tips. All non-cash tips that may be items of value should be recorded, along with the date and value of the item. While non-cash tips don't necessarily need to be reported to an employer, they need to be reported on the person’s tax return.
Reporting tips to an employer
Tips that are received by any employee in any month of the year are subject to medicare and social security taxes and have to be reported to the employer. When a person reports tips to their employer, there isn't a specific form that must be used (unless the employer states otherwise), but the statement must include the employee's signature, address, and social security number. It must include the employer's name and address as well.
The statement also needs to display the relevant time period and the total amount of tips gained during that time. Tips have to be reported to the employer on or by the 10th of each month after the tips are gained. For example, tips received in August need to be reported on or by Sept. 10th. In cases where the 10th lands on a weekend, some employers may give employers until the next business day.
What percentage does an employee claim for taxes?
The percentage of tips claimed is 8 percent. According to the IRS, “If the total tips reported by all employees at a large food or beverage establishment are less than 8 percent of the gross receipts (or a lower rate approved by the IRS), then the employer must allocate the difference among the employees who receive tips.” The allocation is then reported by the employer using Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips. The allocated tips are indicated on the employee’s W2 in box 1.
Tips of less than $20 in a month don't have to be reported, and service charges aren't included in a daily tip record. For unreported tips on an individual income tax return, employees can use Form 4137, Social Security, and Medicare Tax on Unreported Tip Income. When someone fails to report their tips, they'll still need to report the total amount (if over $20) and will be subject to an additional penalty of 50 percent of the total unreported amount.