Server in restaurant receiving taxable tips.

Are Tips Taxable? What Every Server Needs To Know

Sarah Sharkey3-Minute Read
December 17, 2021

Any member of the service industry always appreciates tips. But are tips taxable?

Wherever you earn your tips, you’ll need to consider taxes because the IRS considers tips to be taxable income. With that classification, you’ll need to track your tips, report the income, and pay taxes on the funds.

If you skip reporting your tips as taxable income, the IRS may levy penalties that can take the wind out of your financial sails. Let’s take a closer look at what you need to know about tips and taxes.

Are Tips Taxable?

The IRS considers tips to be taxable income, whether they’re received as cash, gift cards or physical gifts. Employees receiving tips are required to report them to their employer, and must pay federal income tax on tipped earnings of $20 or more per month. And if you are wondering what percentage of tips servers are required to claim, the answer is 100%.

What Counts As A Tip

We’ve established that tips are taxable income. But what counts as a tip?

According to the IRS, “tips are discretionary payments determined by a customer that employees receive from customers.” With that, essentially, anything that a customer chooses to leave behind for you should be counted as a tip.

These payments could include:

  • Cash: Cash left for the server is a tip.
  • Tips on credit card or debit card transactions: When a customer puts a tip on their card, that is taxable income.
  • Gift cards: A gift card with monetary value is considered a tip.
  • Anything left by a customer with monetary value: A noncash tip could be anything from a ticket to a concert to a piece of jewelry.
  • Tip pools: If you receive tips at work through a tip-splitting arrangement or tip jar, that is considered taxable income.

Essentially, any item of value left for a server is considered a tip.

Service Charges Aren’t Tips

But not all extra charges are considered tips. Remember, tips are discretionary payments left by the customer. If the establishment adds a service fee to the bill, that is not a tip.

A few examples of service charges that aren’t tips include bottle service, set gratuities for large parties, and delivery fees. Any of these service charges should not be included as your tipped wages. Instead, the employer should track these charges and report them appropriately.

How To Report Tips On Your Taxes

Since tips are taxed, it is the responsibility of the employee to track and report this income. Here are some ways to keep track of your tip income:

  • Keeping a tip log or journal: Update a log every day that you work.
  • Using a spreadsheet or app: Plug in your tip income immediately after you leave work.

You should report your tips to your employer daily or weekly. The employer needs this information to properly set up withholding taxes that support Social Security and Medicare programs.

As an employee, you’ll need to record your tips that the company doesn’t already track. In some cases, tips left via a debit card or credit card will be reported in the payroll tracking system. But when it comes to cash and other tips, the burden is on you to report the income to your employer.

You can inform your employer of the tips you receive with the IRS Form 4070A. Essentially, you’ll just write down how much you've received in tips for a particular period. Once that form is turned in, the employer will adjust your withholdings appropriately.

But at the end of the year, you’ll still need to report your tips on your income tax return. If you’ve regularly reported your tip income to your employer, this step should be as simple as obtaining your W-2. If you still have unreported tips for the year, then you’ll need to file an IRS Form 4137 at tax time.

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What Happens If You Don’t Track And Report Your Tips

Of course, there are countless reasons why you might not want to track and report your tips. After all, tracking your tips on a regular basis can be somewhat tedious.

But there are big penalties for those who don’t track and report their tips.

First and foremost, your tax return may be audited by the IRS if they suspect you aren’t reporting your tips. An audit is a potentially long and painful process that everyone should avoid. If an audit finds that you’ve underreported tip income, then you could face financial penalties of up to 50% of the Medicare and Social Security taxes owed.

Even if you avoid an audit, underreporting your income can lead to long-term impacts on Social Security income at retirement. You might not receive as much as you could if you reported your income correctly all along.

And finally, underreporting your income can have a negative impact on your credit score if the IRS levies penalties that throw your finances out of whack.

The Bottom Line: Tips Are Taxable

Tips are taxable income that must be reported. Although paying taxes might not be fun, it is an unavoidable part of life. But the good news is that there are plenty of tax deductions that offer a legal way for you to reduce your tax liability. Take the time to learn more about taxes with Rocket HQSM today!

Sarah Sharkey

Sarah Sharkey is a personal finance writer who enjoys diving into the details to help readers make savvy financial decisions. She’s covered mortgages, money management, insurance, budgeting, and more. She lives in Florida with her husband and dog. When she's not writing, she's outside exploring the coast. You can connect with her on LinkedIn.