Restaurant workers rely on tips for a good part of their income. Although it may be difficult for the Internal Revenue Service (IRS) to figure out exactly how much you earn in cash from your satisfied customers, tip income is taxable income. Government rules require that employees who work for tips report them and pay their taxes.
Taxation Begins With Recordkeeping
All employees who work in industries where tips make up most of their income must report their earnings to their employers monthly. If you're a bartender or a waitress, you're expected to keep a daily log of how much you earn each day. You must add up all the entries at the end of the month and submit the total to your employer.
Service Charges Are Wages
Some restaurants include a percentage toward tips in customers' bills, such as a mandatory 18% for parties of six or more. These are service charges, not tips, and you don't have to include these in your tip record. However, you do have to pay taxes on the income. Your employer will typically include these payments on your W-2 as wages earned and will withhold taxes on this income from your paycheck.
Your Wages May Not Cover Tip Withholding
Employers are required to withhold taxes on the tips employees report to them each month. Because tips go directly to the workers, employers typically do this by deducting the taxes due for tips from regular wages. However, most tipped employees earn little in the way of regular wages. Their paychecks may not be enough to cover regular withholding plus withholding for reported tips as well. When this happens, withholding carries over to the next pay period. Employees can also elect to make cash payments to their employers to cover the amount of tax due on their tip income.
Your Employer Can Allocate Tips
Certain employers must "allocate tips." This means that, at a minimum, you pay taxes on tips equaling your share of eight percent of your employer's monthly sales. If your employer's total sales for a month amount to $50,000, he must allocate eight percent of that to employees, or $4,000 for the month. There are different ways to allocate. However, if there are 10 employees, your employer might allocate $400 to each. If you had reported at least $400 in tips to your employer that month, no additional tips would be allocated to you. However, if you had reported only $300, $100 would be allocated to you. You must report allocated tips on your tax return. You must pay tax on them, unless you have records proving that you earned less.
A Tax Lawyer Can Help
The law surrounding payment of income taxes on tips is complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the topic. For more detailed, specific information, please contact a tax lawyer.