Reporting Employee Tips on Tax Returns
The tip allocation procedures often cause confusion when reporting tip income on an employee’s tax return. The following example illustrates the employee tip reporting process according to IRS rules.
Example – Tip Reporting, W-2 to 1040: Jan is a waitress at Walton’s, a large food and beverage establishment. She reported $2,000 in tips to her employer during the year, but did not keep adequate records of tip income. Jan’s Form W-2 showed the following information:
| Wages, Tips, etc. (Box 1) | 9,200.00 | Fed tax withheld (Box 2) | 1,840.00 | |
| SS Wages (Box 3) | 7,200.00 | SS Tax Withheld (Box 4) | 570.40 | |
| Medicare Wages (Box 5) | 9,200.00 | Medicare Tax Withheld (Box 6) | 133.40 | |
| SS Tips (Box 7) | 2,000.00 | Allocated Tips (Box 8) | 1,000.00 |
Explanation of Jan’s Tip Income - Jan will report $10,200 in wages on her Form 1040 ($9,200 in wages plus $1,000 in allocated tips). The allocated tips indicate that the restaurant found a “shortfall” of $1,000 when comparing the tips Jan reported ($2,000) to 8% of her allocable share of the employers’ gross sales. She did not keep a good record of tips, so she had nothing to verify that she had only received $2,000. The allocated tips are added to Jan’s wages and are reported on Form 1040, line 1 (2024 form). Since no social security tax was paid on the allocated tips, Jan must also complete Form 4137 as an attachment to her return – it will include the total OASDI and HI tax assessed on the allocated tips of $76.50. This amount must also be added to Jan’s tax on (2024) Schedule 2, line 5, then carried as part of the Schedule 2 total to Form 1040, Page 2, line 23.