This post might seem more or less like a no-brainer because it talks about two of the types of income that are most commonly found on an individual’s federal tax return. However, it’s always a good idea to have a greater understanding of the ways the money you make shows up on your return. It can be helpful when you review past-submitted returns that you have in your personal records, and can come in handy particularly when an interested third party, like a lender, asks you to break down your income by type. In this vein, here are two of the types of income commonly found on an individual’s income tax return – wages/salaries and tips.
Wages and Salaries
Wages, salaries, and other earnings, found on line 1, of Form 1040, pertain to income earned when the taxpayer is an employee, and the payer is his or her employer. Employee/employer has a special connotation in the tax world because it means that you receive a Form W-2 at the beginning of the following year to memorialize the amount of income paid to you. Legally, as an employee you take direction and management from your employer, or your employer’s agents, and they tell you how to do your job. In other words, you are not self-guided. This is essentially what employment income is, and comes in the form of wages, salaries, bonuses, awards, accrued leave pay, and fringe benefits, just to name a few. Suffice it to say, if you receive a benefit from your employer, it’s most likely taxable income, unless it’s employer-provided health insurance or up to $50,000 in group term life insurance, both of which are not taxed. One other thing to note, pre-tax retirement plan contributions made by your employer for your benefit are not taxed at the time they are contributed, assuming that the retirement plan in which you are participating is qualified, which your employer must tell you in advance, before you contribute.
A lot of people think that tips received through one’s job are not taxable, or specifically cash tips aren’t taxable, or maybe it’s total tips under $10,000 for the year. All these are wrong. The IRS makes it clear that gross income, lines 1 through 7b on Form 1040, means all income from whatever source derived. This unfortunately includes tips, even tips that are not cash, like, for example, a happy patron at a diner tipping his waitress a car.
The IRS recommends that those receiving tips as an employee either: keep a tip diary, or keep records of the tips you receive. A tip diary is, as it sounds, a notebook where you write down the amount of tips received on a given date. The alternative, keeping records, involves restaurant bills or credit card receipts that show the amount tipped. After recording your tips, you must also report them to your employer. This generally should be no problem because most employers want to know this information anyway, so they can properly show the total paid to you on Form W-2. If your employer does not have a way of doing this, report your total tips monthly, using Form 4070, Employee’s Report on Tips to Employer. Any amount over $20 per month is reportable.
Know that any tips you reported to your employer should be included in box 1 of your Form W-2. However, tips that for whatever reason were not reported to your employer still have to be reported on your return. Both reported and unreported tips are combined with all other wages and salaries, and included on line 1 of Form 1040. Note that if you had unreported tips, you may have to pay social security and Medicare taxes on these amounts. In order to pay social security and Medicare on your unreported tips, use Form 4137, Social Security and Medicare Tax on Unreported Tip Income. Finally, “allocated tips” are tips almost always derived from employment at a restaurant or bar that figures the employee’s share of 8% of food and drink sales minus that employee’s portion of tips reported. Allocated tips show up in box 8, of Form W-2. Like tips included in box 1, these allocated tips are combined with wages, salaries, and reported tips and included on line 1 of Form 1040. Also, be aware that you must pay social security and Medicare taxes on these allocated tips because your employer did not withhold these. Like with unreported tips, use Form 4137 to calculate and report social security and Medicare taxes.
For more information on income, as it pertains to personal tax returns, see IRS Publication 17.
If you are having issues with calculating or reporting your income, or have any other tax questions or problems, call Dino Tax Co today at (713) 397-4678, or email us at firstname.lastname@example.org. Also, consider liking us Facebook: www.facebook.com/dinotaxco.