Are Tips Taxable in the United States?

Tips are definitely taxable in the United States. Employees are supposed to report the amount of tips and have the tax withheld. The employer is required to assume that 8% of the bill is given as a tip and deduct the appropriate amount of tax if no tip is reported.

Understanding the Taxability of Tips

Tips are considered taxable income. They are often poorly accounted for, with some employees or employers omitting them from tax forms. This does not mean that you can skip reporting or paying taxes on them. The IRS (Internal Revenue Service) strictly requires that tips be reported and taxed.

Impact on Tips on Employment

This system can be frustrating for employees such as waitstaff who rely on tips to make ends meet. My granddaughter, for example, works as a waitress but due to her hourly wage being disproportionately low compared to her taxable income from tips, she hasn't received a paycheck above zero in years. This creates a complex situation where even with working a reasonable number of hours, her income does not cover basic expenses.

Why Tips Can Lead to Sub-Minimum Wages

Tips-based income can make it easier for employers to pay serving staff sub-minimum wages. In this scenario, the employees rely heavily on tips to meet their minimum wage requirements. Without reporting and accounting for tips, these employees can receive less than the minimum wage, as the total income (including tips) falls below the legally required wage level. This incentivizes the use of tips to supplement low wages and can lead to a sub-optimal working environment.

The Multi-Faceted Taxation of Tips

Tips are not only subject to income tax but also to FICA (Federal Insurance Contributions Act) tax. FICA taxes consist of both Social Security and Medicare taxes. Employers are required to withhold both Social Security and Medicare taxes from employee paychecks, including amounts earned from tips. However, in some cases, employers may not automatically withhold these taxes from tips, especially if no official tip reports are submitted. It is crucial to verify withholding of FICA taxes by checking your W-2 form. Any taxes not withheld from tips will need to be paid by the employee as part of their income tax obligation.

Conclusion

For individuals who rely on tips for a significant portion of their income, understanding the taxability of tips is crucial. Tips must be reported and taxed, which can sometimes lead to complex financial situations. Employers have a responsibility to ensure that appropriate taxes are deducted, but in cases where tips are not reported, employees may need to handle the tax burden themselves. It is always advisable to keep detailed records and seek the assistance of a tax professional to navigate these requirements effectively.