Are Tips Tax Free?

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Tips are not tax-free. Even though they typically come from customers rather than your employer, tips you receive as part of your job are taxable income and must be reported on your tax return. This applies to any job that produces tips -- waiter, bartender, hairdresser, casino dealer, porter, cabdriver or something else entirely.

Types

All types of tips you receive are taxable. They can be tips you get directly from customers. They can be tips collected by your employer and passed on to you, such as those that were paid with a credit card. Or they could be your individual share of a tip pool -- for example, when a restaurant's staff combines all tips for the night and splits them equally. You pay taxes only on the tip money that you actually take home. For example, if you are a waiter, and a restaurant customer tips you $5, and you share $2 of that with a coworker who helped cover the table, you will pay taxes only on $3. The coworker pays taxes on the other $2.

Requirements

The IRS requires you to keep a daily record of your tips. In any month in which you received at least $20 in tips, you must inform your employer of the total amount of your tip income. Your employer will then withhold enough money from your regular pay to cover the Social Security, Medicare and income taxes due on your tips. At year's end, use your daily record to report your total tip income on your tax return; include tips in Line 1, the same line used for wages and salaries.

Unreported Tips

If you have tip income that you did not report to your employer -- from months in which you made less than $20 in tips -- you'll have to pay the Social Security and Medicare taxes on those tips yourself. You do this using IRS Form 4137. If you need Form 4137, then you'll have to file your taxes using the "long form" return, the 1040. You can't use the shorter 1040A or 1040EZ.

Allocated Tips

The IRS requires certain employers -- mostly large restaurants and bars -- to "allocate" tips to their workers. As Bankrate.com puts it, allocated tips represent what the IRS and your employer "think" you should have made in tips based on the amount of food and drink sold by the business. You can tell whether you've had tips allocated to you by looking at the W-2 form you get from your employer. Tips you reported to your employer will be included in Box 1. Allocated tips are identified separately in Box 8. If you've kept a credible and complete daily tip record, then you don't have to report allocated tips as income -- but make sure to retain the tip record in case the IRS questions your return. If you haven't kept a complete tip record, then you must include allocated tips on Line 1 of your tax return.

Consideration

If you get a tip in something other than money, such as theater tickets, you'll owe taxes on the cash-equivalent value of that item. Do not report such tips to your employer, as you do not pay Social Security and Medicare taxes on non-cash income. However, you must include the monetary value of the items on Line 1 of your return.