Tips on recording and reporting tips

I earn tips in my job as a waiter.  Some of the money I keep in my pocket and other tips I turn into a pool at the restaurant, and this is the standard practice with all the waiters.  The tips we turn into the pool get shared with all of us, and they show up on our W-2 form at the end of the year.  I've never paid tax on the tips I pocket.  Is it okay to continue like this? T.S. Indianapolis

First let me say that I'm writing this column from Bristol, England, where waiters don't expect tips and the quality of service is extremely high. Those who are standing around me while I write this column can't understand why the tax on tips is an issue at all.  So, perhaps waiters are paid more here, but the income tax in England is substantially higher than it is in the states, so I think it all evens out in the end. 

Meanwhile, if you are a waiter in the states, it doesn't really matter that the tips are cash in your pocket or part of the employer's pool – in the end you owe tax on everything you earn, whether it's on your W-2 or in your pocket. Here's the way you should be reporting the pocketed tips, if you plan to continue this process.  

First, I'm going to proceed on the assumption that your employer is okay with the fact that you receive tips and don't turn them in or report them to the boss. Keep in mind, however, that many employers expect their wait-staff to tell how much they collect in tips, even if they keep all the money for themselves, then the employer will include the amount on your W-2 form.  

If you are going to take the responsibility for reporting your own tips, keep a very clear record of the tips you receive. The easiest way to record your tip income, and the method the IRS prefers, is to keep a notebook or diary where you track your tips on a daily basis. The IRS always likes paper records, so keeping the diary will be extremely useful evidence for the tips you collect. Even if you plan to report the tips to your employer, the diary provides the best method for keeping track of all that you collect.  

To the extent that you have paper evidence of your tips, such as credit card receipts or restaurant checks, you should also keep this information. The more evidence you can provide to support your daily reportings of your tips, the more authentic your records will be.  

Here's a nice "tip" for you – the IRS publishes a document that you can use to keep track of your tip income. Form 4070A, otherwise known as Employee's Daily Record of Tips, is available from the IRS. You can download the form, which is included in Publication 1244, at the IRS web site, http://www.irs.gov. Choose the Forms and Publications option, then choose Publications, and select Publication 1244 from the list. This publication not only includes instructions for filling out the form 4070A, but it includes a copy of the form which you can duplicate and use for the entire year.  

As far as the IRS is concerned, tips aren't just the cash you receive. Tips also include non-cash items such as tickets to events, passes, and or other items of value. Anything you receive for your services that has value is subject to tax and the value of the amount you receive should be listed on your report of daily tips you receive.  

When it's time to file your tax return, your tips that aren't included in your W-2 form should be added to the amount of wages you report on line 7 of your 1040 (if you are reporting tips that aren't on your W-2, you can't use a 1040A or 1040EZ). Attach a self-prepared statement to your tax return that explains why the amount on this line doesn't agree with the amount on your W-2 form.  

Not only will you be subject to income tax on these tips, but you will also have to pay Social Security and Medicare tax on the tip income. Compute the tax by multiplying 7.65% times the amount of tip income, and add the amount to the line that reads "this is your total tax" on your tax return. To the left of the amount of tax you should write the letters "UT" which stand for "uncollected tax" and also jot down the amount of the uncollected portion of the tax that you are reporting.  

For example, if your tip income not included on your W-2 form totals $600, you will compute $45.90 in tax (round to $46). On the "total tax" line you should increase the computed amount by $46, and to the left of the line write "UT $46."