Tipping is very common in the US, especially in the hospitality industry.
And for those that receive them, tips can account for a significant portion of an employees’ overall pay.
In fact, employers in various states in America are entitled to pay staff working in particular industries below the minimum wage rate, because they receive tips.
If you’re a nonresident employee who receives tips from customers in the US, it is important to understand that this income is taxable and must be reported to the IRS.
If you do not correctly declare all of your income for tax, you will not be fully tax compliant.
As a result, you may incur fines or penalties from the American tax authorities.
But don’t worry, in this article, we will explore everything you need to know about tax as a nonresident that receives tips in the US.
What are tips?
A tip, often referred to as a gratuity, is a sum of money customarily given by a customer to a worker. Tips are particularly common in the hospitality industry and among other services such as taxi drivers, hairdressers, delivery drivers, etc. Tips are payments which are in addition to the basic price of the service.
Tips may be paid by cash or credit / debit card, either directly to an individual staff member or to a communal staff tip jar.
Tips are typically 15 to 20% of the total bill.
Types of tips
Direct tips
Direct tips refer to those received by an employee directly from a customer. Examples of occupations where you are directly tipped include servicers, bartenders, and hairdressers.
Indirect tips
Indirect tips refer to when an employee who does not normally receive tips directly from customers, receives a tip. Examples of occupations where you might receive an indirect tip include bussers, chefs.
Cash tips
Cash tips must be reported to the employer. It includes tips received directly from customers, tips paid by card payment that are distributed to the employee by their employer, and tips received from a tip-sharing arrangement by other employees.
Non-cash tips
Non-cash tips are received in a different medium than cash. Examples of non-cash tips include tickets or other goods received from a customer by the employee. Noncash tips are not reported to the employer.
Pooled tips
Tip pooling involves putting all of the tips received by employees into a fund that is then redistributed to all tipped employees, which is generally split by the employer. Tip pooling ensures that all employees who contribute to the overall customer experience receive a fair share of tips for their work.
Shared tips
Tip sharing is more informal than tip pooling in the sense that it is carried out among employees on their own terms. It involves employees voluntarily sharing tips with other non-tipped employees who helped them during their work shift.
It is important for employees to keep track of their tips earned in cash payments and declare this with their employers and on their tax returns.
With regard to non-cash tips, although employees do not need to notify their employers, they must declare them on their tax return.
Are tips taxable income?
Yes, employees need to pay tax on gratuities.
Tips are subject to social security and Medicare taxes and therefore must be reported to employers in order for them to calculate and withhold the appropriate tax amount from the employee’s paycheck.
Why are tips taxable?
Tips are classified as income and therefore they are taxed accordingly by the IRS, as tips often account for a substantial portion of wages for employees working in the hospitality and service industries in the US.
Do you have to declare tax on tips?
Yes, you are required by the IRS to declare tax on gratuities / tips.
Tips not reported as required may result in a penalty equal to 50% of the Social Security and Medicare taxes that are unpaid.
It is the responsibility of the employee to keep a daily tip record and to report their tips to their employer. The exception to this is if your total tips in a month are less than $20 per employer. In this case, employees do not need to report tips to their employer. However, employees will still have to report these tips on their tax returns at the end of the year.
Employees must report all tips on their individual income tax returns.
Keeping a daily tip record – Form 4070A
You might be wondering how to report tips to an employer.
One option is Form 4070A, which is a tax form that is distributed by the IRS and allows employees to keep a daily record of their tips to report them to their employer.
Although employees are not required to keep track of their tips by using the IRS tip reporting Form 4070A, this provides a convenient way for employees to keep track of their tips.
If you choose not to use Form 4070A to report tips, the statement must include:
- Employee’s signature
- Employee’s name, address and SSN
- Employer’s name and address
- Month that the statement covers
- Total of tips received during this month
As previously mentioned, employees do not have to report non-cash tips to their employers or on a Form 4070A, however, they are considered income by the IRS and must be reported as such in their tax return.
Reporting tips to your employer
Employees must report tips to their employer by the 10th of the following month after the tips are received. For example, tips received by an employee in April 2023 must be reported to the employer by 10 May 2023.
If the 10th falls on a Saturday, Sunday, or public holiday, the employee must report their tips to their employer by the following day, which is not a Saturday, Sunday, or public holiday.
What happens if you don’t report your tips to your employer? Form 4137
Tips not reported to an employer must be declared on Form 4137. This will be used to identify the tax owed on tips that were not reported by an employee to their employer.
When filling out this form, employees must declare all unreported tips. Any additional tax liability is calculated and transferred to the total tax amount reported on the employee’s income tax return.
What about tip sharing schemes?
If you are in a tip pool with other employees, you can deduct the amount you gave to another employee from your tips. For example, if you earn $100 in tips and you give $20 to the busser, you only report your tips as $80 on your Form 4070A.
Are credit card tips taxed on your paycheck?
Yes, credit card tips are taxed on your paycheck in America.
When you receive tips through a credit card the process remains the same. Employers will calculate and withhold the appropriate amount from an employees’ payroll to cover taxes on tips.
Employees have to pay taxes on tips, whether the tips are paid by cash or electronic payment methods.
How is a service charge different from tips?
It is important to note that service charges are not classified as tips. Service charges refer to mandatory charges set by company policy. Reasons why companies may apply a service charge could be due to large parties, delivery fees, or room service charges.
So although your employer may pay you the service charge or a portion of it, it does not qualify as a tip. Although you will pay tax on this service charge, your employer will handle this for you, and it does not have to be reported by the employee as a tip.
What happens if the taxes on your tips are more than your paycheck?
If you earn a large amount of tips, it is possible for your taxes to exceed your paycheck amount. Therefore, your employer will not be able to withhold enough to cover your taxes.
This will result in additional tax liabilities that you will need to pay when you file your income tax return.
In this case, it is recommended that the employee make estimated payments throughout the year to cover unpaid taxes. This will ensure that the employee avoids any penalties by the IRS as a result of underpaying tax, and it will help to avoid a large tax bill at the end of the tax year!
What does allocated tips mean on my Form W-2?
Allocated tips are given to tipped employees by the employer in addition to the tips that the employee has already reported.
Your employer is required to allocate tips if they operate a large food or beverage establishment, if they have employees that receive tips directly from customers, or if the total tips reported by all employees are less than 8% of the employer’s gross sales receipts. In this case, employers must allocate the difference to the employees that receive tips.
Allocated tips on W-2 Form can be found in Box 8. No income tax, social security, or Medicare taxes are withheld on allocated tips.
Are allocated tips taxable?
Yes, allocated tips are also taxable. As there is no tax withheld on allocated tips, employees use Form 4137 to calculate their Social Security and Medicare taxes.
Employees must then report these taxes on their income tax returns.
How do I report tips to the IRS?
As previously mentioned, employees should report tips received to their employer by using Form 4070A, or by written or electronic submission.
At the end of the tax year, employees must report their tips to the IRS on their income tax return. The total tips reported will be added to the employees’ wages to determine their taxable income.
A top tip (pun very much intended!) is to keep track of your tip income to ensure there is no confusion when it comes to reporting it for tax purposes.
In the US, the tax filing deadline usually occurs on 15 April, and therefore employees must file their income tax return on or before this date to avoid any penalties from the IRS for late filing.
How can Sprintax help?
At Sprintax Returns, we know filing taxes can be complicated and time-consuming.
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