Summer is around the corner and for many high school and college students that means a chance to earn extra money. Despite the dwindling number of jobs created by the American economy as recently reported by the Labor Department, many people will have an opportunity this summer to make some money. Summer jobs are usually temporary in nature and many of them pay minimum wage plus tips.
Paying taxes on tips have become a topic of disagreement between the IRS and those who receive them. Regardless of your feeling about that, they have to be reported to your employer and on the tax return. The change in payment method from cash to credit or debit has worked to the advantage of the IRS as any tips received appear on your paycheck and your employer withholds taxes. The question is, what about cash tips? Do you have to report cash tips? How will the IRS know if you don’t declare anything?
To answer the first question, yes, you have to report cash tips on your tax return. No matter how you obtained the tip, it is a form of payment for services provided, therefore taxable. To make it easier for you, the IRS took time to design a form just for that. You fill out Form 4070 and later give it to your employer who withholds appropriate taxes. This form is to report tips on monthly basis and is due until the 10th of the following month. So for tips made in August, due date is September 10th unless the 10th is Saturday, Sunday, or a holiday in which case the due date is the following business day.
When you don’t have to fill out Form 4070? If your monthly tips from a particular job are less than $20.00, there is no need to present this form to your employer. Remember that you still have to add that amount to total wages for the year on the tax return
Form 4070 is a short one, it requires your name, name of the employer, month when you received tips, your social security number, cash tips received, credit and debit tips received, and tips paid out. Even though credit and debit tips are recorded electronically, you still have to report them on this form. Tips that you paid out to others for any reason are subtracted to come up with the net amount you made.
To report tips with more details, the IRS also introduced form 4070A. What is the difference between Form 4070 and 4070A? Both forms are very similar and serve the same purpose of reporting tips to your employer who will later withhold taxes. The main difference is that Form 4070 presents information about the tips you received in a lump sum where Form 4070A is a daily log of tips received. It is arguably a more convenient form as it aids in more accurate reporting, especially if you work full time. Keeping track of money received and paid out is simpler when done is an organized fashion. This form also let’s you write down names of persons to whom you paid out tips making it even easier for you to explain anything should your tax return be questioned.
Naturally, you don’t have you use the Form 4070A per se. As long as you keep a daily log that contains the same categories and report it to your employer, you are fine. Aside from tips, you also have to keep track of any non-cash gifts received, i.e. tickets to different events, and their value. They don’t have to be reported to the employer but you have to include them on your tax return.
What happens is you don’t accurately report your tips? How does IRS know how much you make on tips? For once, keep in mind that other employees may report you as a person to whom they paid out taxes and your employer can report and withhold taxes on those reported payments. Also, it is implausible to expect you don’t make any money on tips in a service industry where all your other coworkers report similar and steady amount. The IRS can assume that you are either very bad at what you’re doing (unlikely) or that you don’t report your income correctly. It is up to you what and how you report things but you should know that there are consequences for lying about your income.
Once you receive your W-2 from your employer, you can potentially find there number you don’t recognize called allocated tips (box 8). IRS mandates that Food and Beverage businesses consider 8% of annual sales as a reference point for tips that should be reported. Then, the total amount of tips actually reported is subtracted from that 8%. If there is any amount left, it is divided between the employees, most often based on the number of hours worked (other methods include Gross Receipt Method and Good Faith Agreement). The amount of allocated tips on your W-2 has to be reported on your tax return as income unless you kept a daily tip log that indicates otherwise or that log shows your total amount of tips received is greater than what you reported plus allocated tips.
Penalties for not reporting tips.
According to IRS Publication 531, failing to report tips to your employer might result in “penalty equal to 50% of the social security and Medicare taxes or railroad retirement tax you owe on the unreported tips.” On top of that, you are still responsible for the taxes on those tips.