Yes, tips are taxable income
The IRS treats tips as income, whether you receive them in cash or by card. You owe federal income tax, Social Security tax, and Medicare tax on all tips you make. This applies to restaurant servers, bartenders, delivery drivers, hairdressers, and anyone else who receives tips as part of their job.
Your employer is required to withhold taxes from your paycheck based on the tips you report. If you do not report tips to your employer, you still owe the taxes — you just have to pay them yourself when you file your tax return, which means a larger bill and possible penalties.
The amount of tax you owe depends on your total income for the year, not just the tips. Tips are added to your wages and taxed at your regular rate.
Key Takeaways
- All tips — cash and card — count as taxable income to the IRS, and you owe federal income tax plus Social Security and Medicare tax on them.
- You must report tips to your employer so they can withhold the correct amount from your paycheck; unreported tips still create a tax debt.
- If your employer does not withhold enough tax on tips, you may owe money when you file your return or receive a smaller refund.
- Card tips are automatically reported to your employer by the payment processor, but cash tips are your responsibility to report.
How employers withhold tax on tips
When you report tips to your manager or through your employer's system, your employer calculates the tax owed and deducts it from your next paycheck. This is called withholding. The employer withholds federal income tax, Social Security tax (6.2 percent of tips), and Medicare tax (1.45 percent of tips).
If you receive tips by card — through a payment app, credit card reader, or digital payment system — the processor reports those tips directly to your employer. You do not have to do anything; the withholding happens automatically. Cash tips are different: you have to tell your employer the amount, usually by writing it down or entering it into a system at the end of your shift.
If you do not report cash tips, your employer cannot withhold tax on them. The IRS still expects you to pay tax on those tips when you file your return. Many people who do not report cash tips end up owing money in April or getting a much smaller refund than they expected.
What happens if you do not report tips
Unreported tips create a tax debt that does not go away. When you file your tax return, the IRS compares what you reported to what your employer reported. If there is a gap, the IRS will add the missing income to your return and send you a bill for the taxes owed, plus interest.
The IRS also imposes penalties for underreporting income. The penalty is usually 20 percent of the unpaid tax, though it can be higher if the IRS determines the underreporting was intentional. Interest accrues from the original due date, so the longer you wait to pay, the more you owe.
If you work in an industry where tips are common — food service, hospitality, personal services — the IRS pays closer attention to tip reporting. Audits in these fields are more frequent than in other occupations.
Reporting tips on your tax return
When you file your federal tax return, you report all income, including tips. Your employer will send you a W-2 form in January that shows your wages and the tips you reported during the year. You use this W-2 to fill out your return.
If you received tips that were not reported to your employer — which should not happen if you reported them correctly, but can occur if you worked for a business that did not track tips properly — you must report those tips yourself on your return. You add them to your other income on the form.
Some people who receive a lot of cash tips keep a daily log or notebook to track what they made. This makes it easier to report accurately and gives you a record if the IRS ever questions your return.
Tips and self-employment tax
If you are a self-employed worker — meaning you are not on a payroll and do not receive a W-2 — tips are still taxable income. You report them on Schedule C when you file your return, and you owe self-employment tax on them in addition to income tax.
Self-employment tax covers both the employee and employer portions of Social Security and Medicare tax, which adds up to 15.3 percent. This is higher than what a regular employee pays because the employer normally covers half. If you are self-employed and receive tips, set aside money for taxes throughout the year so you are not caught short in April.
State and local taxes on tips
Most states tax tips as income, just like the federal government does. Some states have their own withholding rules, and a few have lower tax rates on service industry income. Your state tax return will ask for your total income including tips.
Some cities and counties also tax tips or have special rules for service workers. This varies widely by location. If you work in a major city or a state with high income tax, tips may be subject to local withholding as well. Your employer should withhold for state and local taxes automatically if you live in a state or city that requires it.
Tips and tax refunds
If your employer withholds too much tax on your tips, you will receive a refund when you file your return. If your employer withholds too little, you will owe money. The amount withheld depends on the information you provide on your W-4 form — the form that tells your employer how much to withhold from each paycheck.
If you receive a large amount of tips in some months and very little in others, your withholding may not be accurate for the year as a whole. You can adjust your W-4 to increase or decrease withholding if you expect to owe or receive a refund.
Frequently Asked Questions
Do I have to report cash tips to my employer?
Yes. You must report all cash tips to your employer so they can withhold the correct amount of tax. If you do not report them, you still owe the tax when you file your return, and you may face penalties and interest.
Are credit card tips reported automatically?
Yes. When a customer adds a tip to a credit card or digital payment, the payment processor reports it to your employer automatically. You do not have to do anything — the withholding happens on its own.
What if I work multiple jobs and receive tips at more than one?
Report tips at each job to the respective employer. Each employer withholds based on the tips you report to them. When you file your return, all tips from all jobs are added together and taxed at your overall rate for the year.
Can I deduct tips I give to other workers?
No. Tips you give to coworkers or other workers are not deductible. You pay tax on the tips you receive, and any tips you give out come from your after-tax income.
What if my employer did not withhold tax on tips I reported?
Contact your employer and ask them to correct the withholding. If they refuse or go out of business, you will owe the tax when you file your return. You can also adjust your W-4 to increase withholding on your regular wages to cover the shortfall.