Thursday, May 2, 2013

The Do’s and Don’ts of Income from Tips

Income from tips is a slippery slope when it comes to declaring them on your tax return.  The position of the IRS is very clear – all tips over $20 in a month must be reported to your employer.  The employer is required to withhold federal income tax, Social Security tax and Medicare taxes on the full amount reported.

Tips are no different than any other income in the eyes of the IRS.  Most people are already aware that tips are taxable but feel they can hide some of that income because there is generally no record of it.  The fallacy is that the IRS knows very well what a person averages in tips in a particular type of industry.  If you claim less than what the IRS expects the tips to be, you raise a huge red flag that could cause your return to be audited.   The IRS is likely to err on the side of higher than lower tip amounts.  In addition, tips that are paid via credit card are traceable.  It’s not difficult during an audit to determine the percentage of bills paid via credit card and easily calculate how much was probably paid in cash tips. 

As tempting as underreporting might be, we recommend that you don’t give in to the temptation.  Keep a log of all tips received, including those that are non-cash items such as tickets, passes or anything with value.  These are also taxable and must be reported.  The penalties and interest payments that you will incur from the IRS identifying and assessing underreported tips are unpleasant.  It’s better to bite the bullet and pay as you go than pay for it with penalties and interest later. 

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