Tips are taxable income, and you owe federal income tax, Social Security tax, and Medicare tax on them
The Internal Revenue Service treats tips as wages. Whether you receive cash, card tips, or digital payments, you must report them on your tax return. Your employer is required to withhold taxes from your paycheck based on the tips you report, and you are responsible for reporting any tips your employer does not know about.
The tax rate on tips is the same as the tax rate on regular wages — it depends on your total income and filing status. You will owe 6.2% for Social Security tax and 1.45% for Medicare tax on all tips, plus federal income tax at your marginal rate. Some states and cities also tax tips.
If you do not report tips to your employer, you still owe taxes on them when you file your return. The IRS has methods to estimate unreported tips based on your credit card sales and cash transactions, and underreporting is a common audit trigger.
Key Takeaways
- You must report all tips — cash, card, and digital — as income on your tax return, whether or not your employer withholds taxes.
- Employers withhold Social Security and Medicare taxes from reported tips, but you may owe additional federal income tax when you file.
- If you receive cash tips your employer does not know about, you are still required to report them and pay taxes on them.
- Unreported tips are a common reason for IRS audits, especially if your credit card tips are much higher than your reported cash tips.
- Some states and cities impose their own income tax on tips, in addition to federal taxes.
How employers withhold taxes on reported tips
When you report tips to your employer, they treat the reported amount as part of your wages for that pay period. Your employer withholds federal income tax, Social Security tax, and Medicare tax based on your total pay including tips.
The withholding is calculated using the W-4 form you filled out when you were hired. If you work in a state with income tax, your employer also withholds state income tax. The amount withheld may not cover your full tax bill, especially if you received large tips in a single pay period, because withholding is based on the assumption that your income is steady throughout the year.
You will see the tips you reported listed separately on your pay stub, but they are combined with your wages for tax purposes. If your employer fails to withhold taxes on tips you reported, you are still responsible for paying those taxes when you file your return.
What happens with cash tips your employer does not know about
Cash tips are harder for employers to track, but that does not mean you can avoid reporting them. You are legally required to report all cash tips to your employer or on your tax return. Many workers report cash tips to their employer at the end of each shift or pay period so taxes can be withheld.
If you do not report cash tips to your employer, you must report them on your tax return when you file. You will owe federal income tax, Social Security tax, and Medicare tax on the full amount. You will also owe any state or local income tax that applies in your area.
The IRS cross-references credit card tips (which are recorded) against cash tips you report. If your reported cash tips are much lower than your credit card tips, the IRS may estimate your actual cash tips and adjust your return. This is one of the most common reasons the IRS audits service workers.
Reporting tips on your tax return
Tips are reported on Form 1040 as part of your total income. If you are an employee, your employer will report tips on your W-2 form in boxes 1, 5, and 7. Box 1 includes tips in your wages for federal income tax purposes. Boxes 5 and 7 show tips separately for Social Security and Medicare tax purposes.
When you file your return, you enter the total wages and tips from your W-2 on the appropriate line. If you received tips your employer did not report on your W-2 — because you did not report them to your employer — you must add them to your income on your return. You will owe taxes on this additional amount.
If you are self-employed and receive tips, you report them as part of your business income on Schedule C. You will owe self-employment tax (15.3% combined Social Security and Medicare) on your net profit, which includes tips.
State and local taxes on tips
Most states that have an income tax also tax tips at the same rate as wages. A few states — including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — do not have a state income tax, so tips are not subject to state income tax in those states.
Some cities impose local income tax on tips even if the state does not. New York City, for example, taxes tips as part of your total income. Philadelphia, Columbus, and several other cities do the same. The local tax rate varies by city and is usually between 1% and 4%.
If you work in a state or city with income tax, your employer should withhold it from your paycheck. If they do not, you are still responsible for paying it when you file your return.
Tips and the minimum wage
In most states, employers can count tips toward the minimum wage requirement. This means your employer may pay you less than the federal minimum wage of $7.25 per hour if your tips bring your total earnings up to that amount. However, if your tips do not reach minimum wage, your employer must make up the difference.
Seven states — California, Minnesota, Montana, Nevada, Oregon, Washington, and the District of Columbia — require employers to pay the full minimum wage (or higher) regardless of tips. In these places, tips are additional income on top of your base pay.
Regardless of how your employer structures your pay, you owe taxes on all tips you receive. The tax obligation does not change based on whether tips are counted toward minimum wage.
What to do if you cannot pay the taxes you owe on tips
If you owe taxes on tips and cannot pay the full amount when you file, you have options. You can set up a payment plan with the IRS through their website or by calling 1-800-829-1040. Payment plans allow you to pay your tax bill in monthly installments, though you will owe interest and penalties on the unpaid balance.
If you are facing financial hardship, you may be able to request an offer in compromise, which allows you to settle your tax debt for less than the full amount owed. This is difficult to obtain and requires proof of financial hardship, but it is worth exploring if you owe a large amount.
The key is to file your return on time even if you cannot pay. Filing late triggers additional penalties, and the IRS can take enforcement action including wage garnishment and bank levies.
Frequently Asked Questions
Do I have to report tips if I made very little money?
Yes. The IRS requires you to report all tips, regardless of how much you earned. There is no minimum tip amount that is exempt from reporting. Even if your total income is below the filing threshold for your age and filing status, you should still report tips on your return.
What if my employer withheld taxes but I still owe money when I file?
This happens when your employer's withholding does not cover your full tax bill. You may owe additional tax if you received large tips in a single pay period, or if you have other income sources. You will owe the difference when you file your return, though you may also receive a refund if too much was withheld.
Can I deduct expenses from my tips?
No. Tips are reported as income, and you cannot deduct work-related expenses like uniforms or supplies from the tip amount itself. However, if you are self-employed, you can deduct business expenses from your total income on Schedule C, which reduces your taxable profit.
What happens if the IRS thinks I underreported tips?
The IRS may audit your return and estimate your actual tips based on your credit card sales, cash register records, or industry averages. If they find unreported tips, you will owe back taxes, plus interest and penalties. The penalty for underreporting is usually 20% of the underpaid tax.
Are tips subject to self-employment tax if I am self-employed?
Yes. If you are self-employed, tips are part of your business income and subject to self-employment tax at 15.3%. You report tips as part of your gross receipts on Schedule C and pay self-employment tax on your net profit.