Any tips you receive are considered taxable income and are subject to withholding. If you receive more than $20 per month in tips, you should report that income to your employer. Tip income that you tell your employer about will be reported in box 7 (Social Security tips) of your Form W-2.
The law assumes an average tip rate of 8% and expects employees to report tips that total at least 8% of the gross food and drink sales. If the reported tip income is less than 8%, restaurants and bars with 10 or more employees are required to allocate unreported tip income among their employees. This means that the difference between what is reported and the 8% rate is distributed among the employees and reported to the IRS. This unreported tip income will also be reported in box 8 (Allocated tips) of your W-2.
You’re expected to report your actual tip income whether it’s more or less than your share of the 8% amount. Use Form 4137 to report any tips that you didn’t tell your employer about. If you have any allocated tip income reported on your W-2, TaxCut will make sure this income is properly reported on Form 4137. If you report less than your share, you should be prepared to answer questions about it.
Even if you earn less than $20 a month in tips, you should report your tip income on Form 4137. The same holds true for employees who aren’t required to report tip income to their employers.
To learn more, see IRS Publication 531: Reporting Tip Income.