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4.12 Interest/Dividends/Other Types of Income: Tips

My Form W-2 includes allocated tips. What are they and how are they taxed?

Certain employers must allocate tips if the percentage of tips reported by employees falls below a required minimum percentage of gross sales. To "allocate tips" means to assign an additional amount as tips to each employee whose reported tips are below the required percentage. For additional information on how the rules for tip allocation work, refer to Chapter 6 of Publication 17, Your Federal Income Tax. All tips you receive are taxable. You should keep a record of actual tips received. You can order Publication 1244 (PDF), Employee's Daily Record of Tips and Report to Employer, for this purpose. If you do not have adequate records for your actual tips, you must include the allocated tips shown on your Form W-2 as additional tip income on your return. You must also complete and attach Form 4137 (PDF), Social Security and Medicare Tax on Unreported Tips. For more information on the requirements, refer to Tip Allocation in Publication 531, Reporting Tip Income. Refer to Tax Topic 402, Tips, for other important information.

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My employer included allocated tips on my W-2 in box 1. The allocated tips included were higher than the tips I actually received. Do I have to pay taxes on money I never received?

Allocated tips are reported in box 8 of Form W-2 and should not be included in the amount in box 1. If they have been included in box 1, you need to get a corrected Form W-2 from your employer.

By including the tip amount in box 1, the employer has indicated that this is the tip amount you reported monthly and that Social Security tax and Medicare taxes have been withheld (unless an amount indicating otherwise appears in box 12). Your copies of your monthly tip reports and your daily tip log will enable you to document that you reported a different tip amount if the Form W-2 income continues to be disputed. If you do not receive a corrected Form W-2, enter the amount of wages and tips you believe to be correct on line 7 of Form 1040. Keep your tip records to support the amount you reported.

You normally must report allocated tips (box 8, Form W-2) as income on line 7 of your Form 1040 unless you have a daily tip record documenting that you actually received less tips than the amount allocated to you. If you have adequate documentation of your actual tip amount, include only the amount of tips that were actually received and reported to your employer. This additional amount of tip income, whether it is allocated tips or unreported tips, has not had income tax, social security tax or Medicare taxes withheld. To correct this, the tips should also be entered on Form 4137 (PDF), Social Security and Medicare Tax on Unreported Tips. Enter the tax from Form 4137 (PDF) on line 59 of Form 1040 and attach Form 4137 (PDF) to your return.

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Is it legal for my employer to require me to report 10% of my total sales as tips rather than reporting my actual tips?

No. When you report the actual tips you have received in the form of cash, check, or charge, in a signed and dated report, you are complying with your legal requirement. Your employer cannot legally ask you to do otherwise. Please see Publication 531, Reporting Tip Income, for further information.

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Of my allocated tips, I tip-out 15% to the busboy and 5% to the bar. Where do I deduct this on my tax return?

You cannot deduct tip-outs (the tips you split with other employees) on your tax return. Nor can you deduct them from your allocated tips. The practice of tipping-out is one of the reasons you should keep a detailed daily log of your tips. If you documented that you tip-out, and you reported all your tips to your employer, then you do not include in your income the allocated tips in box 8 of Form W-2.

Tipping-out, by itself, should not cause an allocated tip situation. First, when you report the cash tips you receive, you should report the total tips, then the amount tipped-out. Publication 1244 (PDF), Employee's Daily Record of Tips and Report to Employer, includes Forms 4070 and 4070A, Employee's Report of Tips to Employer that provides lines to record:

  • Cash tips received
  • Credit card tips received
  • Tips paid out
  • Net tips

The detail of the information provided should enable your employer to develop a reasonable, fair, and accurate method for determining whether tips need to be allocated, and, if so, how much. Employers who operate large food and beverage establishments are only required to allocate tips if the total tips reported by all the employees who customarily receive tips are less than 8% of gross sales. Thus, when there is a tip-splitting arrangement, it is important that all tips, including those received through tip-splitting, be reported to the employer by each employee who receives $20 or more in a month.

For more information, refer to Publication 531, Reporting Tip Income.

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If the reported tips from employees are more than 8% of sales, must an employer still allocate tips to the employees?

No. Employers who operate "large food or beverage establishments" must allocate tips among the employees who receive tips only if the reported tips are less than 8% of the gross receipts from sales for that establishment for a given period. Employers can also petition for a lower rate, for additional information refer to Publication 531, Reporting Tip Income.

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Can the 8%, normally used for allocated tips, be a matter agreed upon as reported tips between the employer and employees, so that the employees do not have to report the exact amount of their tips?

No. The law requires that the employee who receives tips must report the actual tip amount to his or her employer if the amount is $20 or more for that calendar month. The 8% figure is not a simplified reporting method. If an employee is customarily tipped between 10% and 20%, reporting only 8% of his or her sales would not only lead to underreporting of income, but also an underpayment of your of Social Security and Medicare taxes.

The employee should keep a tip record of his or her daily tips. A daily tip record can relieve the employee from having to include allocated tips in his or her income by documenting that the amount of tips the employee reported were the actual amount received.

For more information on tip reporting for employees, refer to Chapter 6 of Publication 17, Your Federal Income Tax or Publication 531, Reporting Tip Income.

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More Frequently Asked Tax Questions
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