6.   Tip Income

Table of Contents

    * Introduction
    * Useful Items - You may want to see:
    * Keeping a Daily Tip Record
          o Electronic tip record.
    * Reporting Tips to Your Employer
          o Electronic tip statement.
          o Final report.
          o Tip Rate Determination and Education Program
    * Reporting Tips on Your Tax Return
    * Allocated Tips

Introduction

This chapter is for employees who receive tips.

All tips you receive are income and are subject to federal income tax. You
must include in gross income all tips you receive directly, charged tips
that are paid to you by your employer, and your share of any tips you
receive under a tip-splitting or tip-pooling arrangement.

The value of noncash tips, such as tickets, passes, or other items of value
are also income and subject to tax.

Reporting your tip income correctly is not difficult. You must do three things.

   1.

      Keep a daily tip record.
   2.

      Report tips to your employer.
   3.

      Report all your tips on your income tax return.


This chapter will show you how to do these three things and what to do on
your tax return if you have not done the first two. This chapter will also
show you how to treat allocated tips.
Useful Items - You may want to see:

Publication

    *

      531 Reporting Tip Income
    *

      1244 Employee's Daily Record of Tips and Report to Employer

Form (and Instructions)

    *

      4137
      Social Security and Medicare Tax on Unreported Tip Income
    *

      4070
      Employee's Report of Tips to Employer

Keeping a Daily Tip Record
Why keep a daily tip record?   You must keep a daily tip record so you can:

    *

      Report your tips accurately to your employer,
    *

      Report your tips accurately on your tax return, and
    *

      Prove your tip income if your return is ever questioned.

How to keep a daily tip record.   There are two ways to keep a daily tip
record. You can either:

   1.

      Write information about your tips in a tip diary, or
   2.

      Keep copies of documents that show your tips, such as restaurant
bills and credit card charge slips.

You should keep your daily tip record with your personal records. You must
keep your records for as long as they are important for administration of
the federal tax law. For information on how long to keep records, see
Publication 552, Recordkeeping for Individuals.

   If you keep a tip diary, you can use Form 4070A, Employee's Daily Record
of Tips. To get Form 4070A, ask the Internal Revenue Service (IRS) or your
employer for Publication 1244. Publication 1244 includes a year's supply of
Form 4070A. Each day, write in the information asked for on the form.

  If you do not use Form 4070A, start your records by writing your name,
your employer's name, and the name of the business if it is different from
your employer's name. Then, each workday, write the date and the following
information.

    *

      Cash tips you get directly from customers or from other employees.
    *

      Tips from credit card charge customers that your employer pays you.
(Also include tips from debit card charge customers.)
    *

      The value of any noncash tips you get, such as tickets, passes, or
other items of value.
    *

      The amount of tips you paid out to other employees through tip pools
or tip splitting, or other arrangements, and the names of the employees to
whom you paid the tips.

Caution
Do not write in your tip diary the amount of any service charge that your
employer adds to a customer's bill and then pays to you and treats as
wages. This is part of your wages, not a tip.
Electronic tip record.   You may use an electronic system provided by your
employer to record your daily tips. You must receive and keep a paper copy
of this record.

Reporting Tips to Your Employer
Why report tips to your employer?   You must report tips to your employer
so that:

    *

      Your employer can withhold federal income tax and social security and
Medicare taxes or railroad retirement tax,
    *

      Your employer can report the correct amount of your earnings to the
Social Security Administration or Railroad Retirement Board (which affects
your benefits when you retire or if you become disabled, or your family's
benefits if you die), and
    *

      You can avoid the penalty for not reporting tips to your employer
(explained later).

What tips to report.   Report to your employer only cash, check, debit, or
credit card tips you receive.

  If your total tips for any one month from any one job are less than $20,
do not report the tips for that month to that employer.

   Do not report the value of any noncash tips, such as tickets or passes,
to your employer. You do not pay social security and Medicare taxes or
railroad retirement tax on these tips.

How to report.    If your employer does not give you any other way to
report tips, you can use Form 4070. Fill in the information asked for on
the form, sign and date the form, and give it to your employer. To get a
year's supply of the form, ask the IRS or your employer for Publication 1244.

  If you do not use Form 4070, give your employer a statement with the
following information.

    *

      Your name, address, and social security number.
    *

      Your employer's name, address, and business name (if it is different
from the employer's name).
    *

      The month (or the dates of any shorter period) in which you received
tips.
    *

      The total tips required to be reported for that period.

You must sign and date the statement. You should keep a copy with your
personal records.

  Your employer may require you to report your tips more than once a month.
However, the statement cannot cover a period of more than one calendar month.

Electronic tip statement.   Your employer can have you furnish your tip
statements electronically.

When to report.   Give your report for each month to your employer by the
10th of the next month. If the 10th falls on a Saturday, Sunday, or legal
holiday, give your employer the report by the next day that is not a
Saturday, Sunday, or legal holiday.

Example 1.

You must report your tips received in April 2006 by May 10, 2006.

Example 2.

You must report your tips received in May 2006 by June 12, 2006. June 10th
is on a Saturday, and the 12th is the next day that is not a Saturday,
Sunday, or legal holiday.
Final report.   If your employment ends during the month, you can report
your tips when your employment ends.

Penalty for not reporting tips.   If you do not report tips to your
employer as required, you may be subject to a penalty equal to 50% of the
social security and Medicare taxes or railroad retirement tax you owe on
the unreported tips. (For information about these taxes, see Reporting
social security and Medicare taxes on tips not reported to your employer
under Reporting Tips on Your Tax Return, later.) The penalty amount is in
addition to the taxes you owe.

  You can avoid this penalty if you can show reasonable cause for not
reporting the tips to your employer. To do so, attach a statement to your
return explaining why you did not report them.

Giving your employer money for taxes.   Your regular pay may not be enough
for your employer to withhold all the taxes you owe on your regular pay
plus your reported tips. If this happens, you can give your employer money
until the close of the calendar year to pay the rest of the taxes.

  If you do not give your employer enough money, your employer will apply
your regular pay and any money you give to the taxes in the following order.

   1.

      All taxes on your regular pay.
   2.

      Social security and Medicare taxes or railroad retirement tax on your
reported tips.
   3.

      Federal, state, and local income taxes on your reported tips.

   Any taxes that remain unpaid can be collected by your employer from your
next paycheck. If withholding taxes remain uncollected at the end of the
year, you may be subject to a penalty for underpayment of estimated taxes.
See Publication 505, Tax Withholding and Estimated Tax, for more information.

  
Caution
Uncollected taxes. You must report on your tax return any social security
and Medicare taxes or railroad retirement tax that remained uncollected at
the end of 2005. See Reporting uncollected social security and Medicare
taxes on tips under Reporting Tips on Your Tax Return , later. These
uncollected taxes will be shown in box 12 of your 2005 Form W-2 (codes A
and B).

Tip Rate Determination and Education Program

Your employer may participate in the Tip Rate Determination and Education
Program. The program was developed to help employees and employers
understand and meet their tip reporting responsibilities.

There are two agreements under the program: the Tip Rate Determination
Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). In
addition, employers in the food and beverage industry may be able to get
approval of an employer-designed EmTRAC program. For information on the
EmTRAC program, see Notice 2001-1, which is on page 261 of Internal Revenue
Bulletin 2001-2 at www.irs.gov/pub/irs-irbs/irb01-02.pdf.

If you are employed in the gaming industry, your employer may have a Gaming
Industry Tip Compliance Agreement Program. See Revenue Procedure 2003-35,
which is on page 919 of Internal Revenue Bulletin No. 2003-20 at
www.irs.gov/pub/irs-irbs/irb03-20.pdf.

Your employer can provide you with a copy of any applicable agreement. If
you want to learn more about these agreements, contact your local IRS
Taxpayer Education Communication (TEC) office. You may call 1-800-829-4933
for the IRS TEC office in your area or send an email to
TEC.TIP.Program@irs.gov.
Reporting Tips on Your Tax Return
How to report tips.    Report your tips with your wages on line 1, Form
1040EZ, or line 7, Form 1040A or Form 1040.

What tips to report.   You must report all tips you received in 2005,
including both cash tips and noncash tips, on your tax return. Any tips you
reported to your employer for 2005 are included in the wages shown in box 1
of your Form W-2. Add to the amount in box 1 only the tips you did not
report to your employer.

  
Caution
If you received $20 or more in cash and charge tips in a month and did not
report all of those tips to your employer, see Reporting social security
and Medicare taxes on tips not reported to your employer , later.

  
Caution
If you did not keep a daily tip record as required and an amount is shown
in box 8 of your Form W-2, see Allocated Tips , later.

  If you kept a daily tip record and reported tips to your employer as
required under the rules explained earlier, add the following tips to the
amount in box 1 of your Form W-2.

    *

      Cash and charge tips you received that totaled less than $20 for any
month.
    *

      The value of noncash tips, such as tickets, passes, or other items of
value.

Example.

John Allen began working at the Diamond Restaurant (his only employer in
2005) on June 30 and received $10,000 in wages during the year. John kept a
daily tip record showing that his tips for June were $18 and his tips for
the rest of the year totaled $7,000. He was not required to report his June
tips to his employer, but he reported all of the rest of his tips to his
employer as required.

John's Form W-2 from Diamond Restaurant shows $17,000 ($10,000 wages plus
$7,000 reported tips) in box 1. He adds the $18 unreported tips to that
amount and reports $17,018 as wages on his tax return.
Reporting social security and Medicare taxes on tips not reported to your
employer.    If you received $20 or more in cash and charge tips in a month
from any one job and did not report all of those tips to your employer, you
must report the social security and Medicare taxes on the unreported tips
as additional tax on your return. To report these taxes, you must file a
return even if you would not otherwise have to file. You must use Form
1040. (You cannot file Form 1040EZ or Form 1040A.)

   Use Form 4137 to figure these taxes. Enter the tax on line 59, Form
1040, and attach Form 4137 to your return.

  
Caution
If you are subject to the Railroad Retirement Tax Act, you cannot use Form
4137 to pay railroad retirement tax on unreported tips. To get railroad
retirement credit, you must report tips to your employer.

Reporting uncollected social security and Medicare taxes on tips.   If your
employer could not collect all the social security and Medicare taxes or
railroad retirement tax you owe on tips reported for 2005, the uncollected
taxes will be shown in box 12 of your Form W-2 (codes A and B). You must
report these amounts as additional tax on your return. You may have
uncollected taxes if your regular pay was not enough for your employer to
withhold all the taxes you owe and you did not give your employer enough
money to pay the rest of the taxes.

   To report these uncollected taxes, you must file a return even if you
would not otherwise have to file. You must use Form 1040. (You cannot file
Form 1040EZ or Form 1040A.) Include the taxes in your total tax amount on
line 63, and write “UT” and the total of the uncollected taxes on the
dotted line next to line 63.

Allocated Tips

If your employer allocated tips to you, they are shown separately in box 8
of your Form W-2. They are not included in box 1 with your wages and
reported tips. If box 8 is blank, this discussion does not apply to you.
What are allocated tips?   These are tips that your employer assigned to
you in addition to the tips you reported to your employer for the year.
Your employer will have done this only if:

    *

      You worked in a restaurant, cocktail lounge, or similar business that
must allocate tips to employees, and
    *

      The tips you reported to your employer were less than your share of
8% of food and drink sales.

How were your allocated tips figured?   The tips allocated to you are your
share of an amount figured by subtracting the reported tips of all
employees from 8% (or an approved lower rate) of food and drink sales
(other than carryout sales and sales with a service charge of 10% or more).
Your share of that amount was figured using either a method provided by an
employer-employee agreement or a method provided by IRS regulations based
on employees' sales or hours worked. For information about the exact
allocation method used, ask your employer.

Must you report your allocated tips on your return?   You must report
allocated tips on your tax return unless either of the following exceptions
applies.

   1.

      You kept a daily tip record, or other evidence that is as credible
and as reliable as a daily tip record, as required under rules explained
earlier.
   2.

      Your tip record is incomplete, but it shows that your actual tips
were more than the tips you reported to your employer plus the allocated tips.

If either exception applies, report your actual tips on your return. Do not
report the allocated tips. See What tips to report under Reporting Tips on
Your Tax Return, earlier.

How to report allocated tips.   If you must report allocated tips on your
return, add the amount in box 8 of your Form W-2 to the amount in box 1.
Report the total as wages on line 7 of Form 1040. (You cannot file Form
1040EZ or Form 1040A.)

   Because social security and Medicare taxes were not withheld from the
allocated tips, you must report those taxes as additional tax on your
return. Complete Form 4137, and include the allocated tips on line 1 of the
form. See Reporting social security and Medicare taxes on tips not reported
to your employer under Reporting Tips on Your Tax Return, earlier.