Tax Tips about Tip Income

The IRS, for some time now, has been trying to combat the underreporting of tip income by waiters and waitresses.  Tips received by individuals are subject to Federal and state (if applicable) income taxes plus Social Security and Medicare taxes.  Also taxable are the value of non-cash tips, such as tickets, passes, or other items of value.

Tipped employees are supposed to keep track of their tips.  If they amount to $20 or more for the month, the employees are supposed to report the tips to their employer who will, in turn, withhold taxes and report the tips on the employees’ W-2s for the year.  Because the employees frequently underreport their tips, the IRS requires large food and beverage establishments to allocate 8% of the establishment’s income as tips reportable to the employees.  Underreporting occurs if an employee reports tips which are less than 8% of the employee’s applicable share of the employer’s gross sale.  The employer must allocate to those underreported employees the difference between the employee’s actual reported tips and the 8% of gross sales.  The allocation amount is noted on the employee’s W-2, but does not have to be reported as additional income if the employee has adequate records to show that the amount is incorrect.

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