Tips paid in cash, a cash equivalent, or a non-cash transaction are taxable income and are treated as wages subject to FICA, FUTA, and income tax.
You should report tips to your employer on Form 4070, or by another method defined by your employer. All tips should be reported to your employer so your employer can report the correct amount of wages to the Social Security Administration.
Tips reported to your employer are reported in box 1 of Form W-2 and are subject to income tax withholding.
Tips should be reported monthly by the 10th day of the next month. For example, you must report tips received in May to your employer by June 10. If the due date falls on a Saturday, Sunday or legal holiday, the due date is extended to the next business day.
If you do not report tips to your employer, you may be subject to a penalty equal to 50 percent of the Social Security and Medicare taxes that you owe on the unreported tips. The unreported tips must be reported on Form 4137 of your tax return.
Allocated tips are tips assigned to you by your employer. These tips are in addition to the tips that you report to your employer. Your employer can allocated tips only if all the following are true:
- You worked in a restaurant, cocktail lounge, or similar business that must allocate tips to employees.
- The tips you reported to your employer were less than your share of 8 percent of food and drink sales.
- You did not participate in your employer's Attributed Tip Income Program.
Allocated tips are reported in box 8 of Form W-2 and are not subject to social security and Medicare tax withholding. You must fill out Form 4137, reporting the amount from box 8 on line 1.
For more information, see IRS Publication 531.