Barry Dolowich, Tax Tips: Reporting tip income - Monterey Herald

Question:  On my 2020 tax return I got whacked with a large tax liability. I am a waiter for a fairly high-end restaurant and my employer allocated tips to me on my 2020 Form W-2 causing me to owe a ton of taxes. Because of the pandemic, I figured I did not need to report any tips from the takeout tips. As a tipped employee, what am I supposed to report to my employer and what records do I have to keep? Also, what do I do to prevent future surprises?

Answer: Reporting your tip income correctly is not difficult. You must do three things:

1. Keep a daily record,
2. Report tips to your employer, and
3. Report all tips you receive on your income tax return.

You must keep a daily tip record so you can:

• Report your tips accurately to your employer,
• Report your tips accurately on your tax return, and
• Prove your tip income if your return is ever questioned or audited.

There are two ways to keep a daily tip record. You can either write information about your tips in a tip diary or keep copies of documents that show your tips, such as restaurant bills and credit card charge slips. You should keep your daily tip record with your personal records, not with your employer.

If you keep a tip diary (my recommendation!), you can use IRS Forms 4070, Employee’s Report of Tips to Employer, and 4070A, Employee’s Daily Record of Tips. To receive a supply of Forms 4070 and 4070A, ask your employer, your accountant, or obtain IRS Publication 1244. However, if you can not obtain the forms, you can create your own acceptable records by creating a schedule including your name, your employer’s name, and the name of the business if it is different from your employer’s name. Then, each workday, write the date and the following information:

• Cash tips you get directly from customers or other employees,
• Tips from credit card charge customers that your employer pays you,
• The value of any noncash tips you get, such as tickets, passes, or other items of value,
• The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees to whom you paid the tips.
• Report the net tips you received to your employer at the end of each pay period.

You must report tips to your employer so that:

• Your employer can withhold federal and state income taxes and social security and Medicare taxes,
• Your employer can report the correct amount of your earnings to the Social Security Administration (which affects your benefits when you retire or if you become disabled, or your family’s benefits if you die), and
• You can avoid the penalty for not reporting tips to your employer (you may be subject to a penalty of 50% of the social security and Medicare taxes you owe).

Your employer may allocate tips to you if your reported tips were less than your share of 8% of food and beverage sales. If your employer allocates tips to you, they are shown separately in box 8 of your Form W-2. You must report allocated tips on your return unless either of the following exceptions applies:

1. You kept a daily tip record as required under the rules explained above, or
2. Your tip record is incomplete, but it shows that your actual tips were more than the tips you reported to your employer plus the allocated tips.

If you must report allocated tips on your tax return, you must pay income tax and social security and Medicare taxes on the allocated tips.

Over the past number of years, the IRS has been on a campaign to “encourage” tipped employees to properly and accurately report their tip income. Because tip income often is received in the form of cash, employees are tempted to under-report their income. However, the IRS can easily estimate any under-reported tip income by utilizing the percentage of tips per charged sales and applying this percentage to the sales attributable to your total customer sales (which includes both charge and cash sales). So, keep organized and accurate records!

Monterey resident Barry Dolowich is a certified public accountant and owner of a full-service accounting and tax practice with offices in Monterey. He can be reached at 831-372-7200. Please address any questions to Barry at P.O. Box 710 Monterey, CA 93942-0710 or email: bdolowich@gmail.com.

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