First all tips received from customers are taxable income and must be reported on Form 1040. Tips are also subject to 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.
Total tip income includes 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.
By using IRS Publication 1244, Employee's Daily Record of Tips and Report to Employer, you can record all tips received so you can:
- Report tips to your employer
- Report tips on the tax return accurately
- Prove your tip income if your return is ever questioned.
If all tips were not reported to the employer as required, the unreported tips should be manually added to line 7 of Form 1040. Since social security and Medicare taxes were not withheld from this income, the taxpayer will need to complete Form 4137 Social Security and Medicare Tax on Unreported Tip Income to calculate the additional tax owed.
Allocated tips are reported in box 8 on Form W-2. The IRS requires food and drink establishments to allocate tips to employees whose reported tips are less than a certain percentage of total food and drink during their shifts. Unless the employee can prove they received a smaller amount of tips shown in box 8, the allocated tips must be added to line 7 of Form 1040 and Form 4137 must be completed.