Federal tax law requires you to report tips as income, even though many people do not

Tips are taxable income under federal law. The Internal Revenue Service treats tips the same way it treats wages: you owe income tax on them, and your employer owes payroll taxes on them. There is no exemption for tips, no matter how small the amount or how the tip was given to you.

The confusion exists because tip reporting is inconsistent in practice. Cash tips are often unreported because no paper trail exists. Credit card tips are tracked by employers and reported to the IRS. The difference between what gets reported and what actually happens is large, but that gap does not change what the law requires.

Key Takeaways

  • The IRS requires you to report all tips—cash and card—as taxable income on your federal tax return.
  • Your employer must withhold income tax and payroll taxes from your paycheck based on reported tips, whether you report them or not.
  • If you do not report tips to your employer, you still owe taxes on them when you file your return, and underreporting can trigger an audit.
  • Some states and cities have their own tip tax rules that may differ from federal law, so check your local requirements.

How the IRS treats tips as income

Tips count as wages for both income tax and payroll tax purposes. If you receive tips, you are required to report them to your employer and include them on your tax return. The IRS does not distinguish between tips earned through good service and tips given for any other reason—all of it is taxable.

Your employer is required to withhold federal income tax, Social Security tax (6.2 percent), and Medicare tax (1.45 percent) from your regular paycheck. If you report tips to your employer, they withhold taxes on those tips too. If you do not report tips, you still owe the taxes when you file your return, and you may owe penalties and interest on top of that.

The threshold for reporting tips to your employer is $20 or more in a calendar month. If you earn less than $20 in tips in a month, you do not have to report them to your employer, but you still have to report them on your tax return when you file.

Cash tips versus credit card tips

Credit card tips are automatically recorded by the payment processor and reported to your employer. Your employer then reports them to the IRS on your W-2 form. There is a clear paper trail, and taxes are withheld from your paycheck.

Cash tips have no automatic record. You are responsible for tracking them and reporting them to your employer. Many workers do not, and many employers do not enforce it. However, the IRS can still audit you based on your income level, the type of work you do, or a tip audit of your employer. If the IRS suspects underreporting, it may estimate your tips based on your sales or the average tip rate for your industry and assess back taxes.

What happens if you do not report tips

Not reporting tips does not erase the tax debt. If you underreport income, the IRS can discover it through an audit of your employer, a tip audit of your workplace, or a comparison of your reported income to your spending patterns. The penalties are real: you owe the unpaid tax, plus interest (currently around 8 percent per year), plus a penalty for underpayment that can reach 20 percent of the unpaid tax.

Tip audits are common in industries with high cash tips—restaurants, bars, salons, and delivery services. The IRS may contact your employer and ask for records of sales, credit card tips, and reported cash tips. If the numbers do not add up, the IRS can assess tips to you based on industry averages or your employer's records.

Self-reporting tips to your employer protects you because it creates a record and shows good faith. If you are audited, you can point to your W-2 and show that you reported what you earned.

State and local tip taxes

Most states follow federal law and tax tips as income. However, a few states have different rules. Some states do not tax tips at all, while others have lower tax rates on tips than on wages. A small number of states allow employers to count tips toward the minimum wage, which affects how much you take home.

Cities and counties may also have their own rules. New York City, for example, taxes tips as income but has specific rules about how employers must handle tip reporting. Some cities have passed laws protecting tip pooling or requiring employers to pay out tips within a certain timeframe.

Check your state and local tax authority websites to understand the rules where you work. The rules vary enough that what applies in one state may not explore in another.

How to report tips on your tax return

If you receive tips, your employer reports them on your W-2 form in Box 5 (Medicare wages and tips) and Box 7 (Social Security tips). You use these amounts when you file your tax return. If you earned tips that were not reported to your employer—because they were below $20 in a month or because you did not report them—you add them to your income on Schedule 1 (Other Income) when you file.

Keep records of your tips throughout the year. A straightforward notebook or spreadsheet with the date, amount, and whether it was cash or card is enough. If you are audited, this record shows the IRS that you tracked your income and reported it honestly.

If your employer did not report tips on your W-2 that you actually earned and reported to them, contact your employer and ask for a corrected W-2. If they refuse, you can file Form 8949 (Sales of Capital Assets) or attach a statement to your return explaining the discrepancy.

Frequently Asked Questions

Do I have to report tips under $20 a month?

You do not have to report tips under $20 in a calendar month to your employer. However, you still owe federal income tax on them. Include them on your tax return when you file. Tracking all tips, even small amounts, is the safest approach.

Can my employer take a tip credit toward minimum wage?

Federal law allows employers in most states to pay tipped employees $2.13 per hour if tips bring them to at least the federal minimum wage of $7.25 per hour. Some states set a higher minimum wage for tipped workers or do not allow a tip credit at all. Check your state's labor department website to see what applies where you work.

What if I report tips to my employer but they do not appear on my W-2?

Contact your employer when ready and ask for a corrected W-2. If they refuse or say the tips were not reported to the IRS, file a complaint with your state's labor department or the Department of Labor. You can also report the discrepancy on your tax return with a written explanation.

Can the IRS estimate my tips if I do not report them?

Yes. The IRS can estimate your tips based on your sales, your employer's records, or the average tip rate for your industry. If you are audited and your reported tips are lower than the estimate, you owe taxes on the estimated amount plus penalties and interest.

Do I owe self-employment tax on tips?

No. Tips are treated as wages, not self-employment income. Your employer withholds Social Security and Medicare taxes from your paycheck. You do not file Schedule SE (Self-Employment Tax) for tips unless you are truly self-employed in another business.