The IRS may be about to crack down on the reporting of tip income. We suggest this because the IRS has just released another article on its website about what is tip income and it has reminders about how it should be reported to employers and to the IRS and what forms are used. When we see things like this it makes us expect to see a crack down on accurate reporting.
We expect to see other crackdowns coming as the IRS trains new revenue agents and expands its enforcement efforts as a part of the recent legislation that gave the IRS about $40-billion for enforcement.
WHAT THE IRS IS SAYING ABOUT TIPS
The IRS says “tips are optional cash or noncash payments that customers make to employees,” and they are taxable. We are really curious about the IRS pointing out “noncash payments” in its newest website article.
Here is how the IRS summarizes cash tips and noncash tips:
- Cash tips include: those received directly from customers, electronically paid tips distributed to the employee by their employer and tips received from other employees under any tip-sharing arrangement. All cash tips must be reported to the employer.
- Noncash tips are those of value received in any other medium than cash, such as: tickets, passes or other goods or commodities that a customer gives the employee. Noncash tips aren’t reported to the employer.
Did you read that last line? “Noncash tips aren’t reported to the employer,” the IRS says, but that doesn’t mean they are not taxable. Noncash tips are taxable. More on that below.
WHAT THE IRS SAYS QUALIFIES AS A TIP
The IRS says four factors determine whether a payment qualifies as a tip. Normally, all four must apply:
- The customer makes the payment free from compulsion;
- The customer must have the unrestricted right to determine the amount;
- The payment should not be the subject of negotiations or dictated by employer policy; and
- Generally, the customer has the right to determine who receives the payment.
That’s what the IRS says. But what happens when you take 12 relatives to a restaurant and the restaurant adds to your check an 18% gratuity for the wait staff? Is that a tip? Actually it is, because the customer could say to the manager that the wait staff screwed up and isn’t entitled to a tip. I’ve never heard of a restaurant that enforced a tip for a large party (usually a party of more than 6 or 8).
DIRECT AND INDIRECT TIPS
The IRS says a direct tip occurs when an employee receives it directly from a customer, even if it is part of a tip pool. Examples of directly-tipped employees include waiters, waitresses, bartenders and hairstylists. When you tip your hairstylist they might share their tip with the person who washes your hair, or with the person who cleans up the salon. When you tip a casino cocktail server, that server might share the tip with the bartender who poured the drinks. When you tip a poker dealer, that dealer might share the tip with cleaners or chip runners in the casino. (A chip runner brings chips to the table for the dealer or for other players.}
So what is an indirect tiip? An indirect tip occurs when an employee, who normally does not receive tips directly from customers, receives a tip. Examples of indirectly-tipped employees include bussers, service bartenders, cooks and salon shampooers. Yes, the other employees who might share in the tip you give to someone else.
KEEPING TIP RECORDS
Here’s why we think the IRS might be about to crack down on tips. The IRS in its latest article is reminding employees that they must keep a daily tip record. Specificially the IRS says: ?Employees must keep a daily record of the cash tips they receive. They can use Form 4070A, Employee’s Daily Record of Tips, which is included in to keep daily track of the cash tips they receive.”
And here’s more about those noncash tips mentioned at the beginning of this report. The IRS says there must be records of noncash tips including their value. Here is the exact wording from the IRS:
“They should also keep a record of the date and value of any noncash tips, such as tickets, passes or other items of value. Although they don’t report noncash tips to their employer, they must report them on their tax return.”
That language is very specific. Employees who received noncash tips don’t have to report their noncash tips to their employers, but they do have to report them to the IRS. So if you receive tickets to a ballgame, or a bottle of wine, you have to estimate its value and report that as income.
This raises all sorts of questions about how do you value certain noncash items. But there are guides for the value of donated items to charity, so it makes sense that you could use these values to figure the value of noncash tips. When it comes to ballgame tickets or a bottle of wine, using resale values probably makes sense.
REPORTING TIPS TO EMPLOYERS
There is yet another indication that the IRS is about to crackdown on the reporting of tip income. The IRS in its website article is reminding employees how to report their tips to employers. As the IRS points out, “there is no required form” from the IRS but each employee must make a statement to employers and the statement must include:
- Employee signature;
- Employee’s name, address and social security number;
- Employer’s name and address (establishment name if different);
- Month or period the report covers; and
- Total of tips received during the month or period.
Employees must report tips to the employer by the 10th of the month following the month the tips were received. Remember that not every employee works in a restaurant where tips are given using a credit card. So these employees who receive cash tips and yes noncash tips too are required to keep their own log.
Again, noncash tips such as tickets and bottles of wine are not reported to employers.
If you want a form to use to report your tips to your employer, the employee can use Form 4070, Employee’s Report of Tips to Employer. But this is not a required form. The IRS says be sure whatever form you use includes the above elements required for reporting.
THERE IS A REPORTNG THRESHOLD FOR TIPS
But here is something that is very important for employees who aren’t normally tipped. The IRS says employees don’t have to report tip amounts of less than $20 per month per employer. Clearly, this will remove the burden on the employee who rarely is tipped.
REPORTING TIPS ON YOUR INDIVIDUAL TAX RETURN
Here’s where we get to the bottom line for your money. The IRS in its latest article clearly spells out the reporting of tips on your individual tax return. The IRS says tips reported to the employer by the employee are included on the employee’s W2 and that must be reported on the individual’s return. Remember, the IRS gets a copy of your W2 so don’t try to ignore it or pretend you never received it.
What about those noncash tips? Here’s where you, the employee, will face a bit of a headache. The IRS says “any tips that the employee didn’t report to the employer (such as noncash tips) must be reported separately on Form 4137” which is the form for Social Security and Medicare Tax on Unreported Tip Income. This form gets included with your tax return and the IRS says “the employee must also pay the employee share of Social Security and Medicare tax owed on those tips.”
Who knew that getting ballgame tickets or a bottle of wine as a tip could be so much trouble?
And there you have it. The rules from the IRS and a warning that it looks like the IRS is about to crack down on reporting tip income. And tip income just isn’t cash.
TALK TO A TAX PROFESSIONAL
If you have a question about tip income or how to report noncash tips, or if you have any tax issue, it is always best to discuss your issue with a tax professional. Our tax resolution experts will give you a free telephone consultation. We’ll help you figure out what you need to do and we’ll tell you about the services we offer. And remember this website is free to use and there are no membership fees. Please watch my video below.
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