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Allocated Tips

Strategies and IRS Audits

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Strategies for Allocated Tips

Having allocated tips reported on your W-2 box 8 is generally not in your best interest. Here's how to protect yourself.

Take a look at your record of daily tips. If you don't have a record of daily tips, you need to get in the habit of doing this. Your system doesn't need to be fancy, just keep track of your daily tips on a calendar, day planner, or little notebook. Why do you need to do this? If you ever get audited on your tip income, you will need evidence of what you actually received in tips.

If you do have a daily tip record, what is the total amount of tips you received for the year? Did you report this amount to your employer? Look on your W-2. Does box 7 (Social Security tips) and box 8 (Allocated tips) add up to the same amount in your daily record? Is your allocated tips (box 8) more than, the same as, or less the total tips you recorded in your daily log?

If your allocated tips are more than what's recorded in your daily log, then you may use your daily log instead of the amount reported as allocated tips. If there are any additional unreported tips, use the amounts from your daily records to fill out Form 4137. Be prepared for lots of mail from the IRS and a tip audit. Keep your daily record of tips with your tax return, so that you are ready when the IRS auditor asks to see your records.

If your allocated tips are the same as what's recorded in your daily log, and you reported your tips to your employer, then it is likely that your employer reported this amount in the wrong place. Ask your employer if this amount should have been reported on box 7 (Social Security tips) instead of box 8 (Allocated tips). If they don't correct your W-2, then just go ahead and fill out Form 4137 using the figure in box 8.

If your allocated tips are less than what's recorded in your daily log, and you reported your tips to your employer, then it is likely that something is wrong with your employer's recordkeeping system. You can ask your employer to correct your W-2. You should report the allocated tips on Form 4137, plus any additional tips you show in your daily records.

What if you have no records of your tip income? First, read page 5 of Publication 531 Reporting Tip Income (PDF). This explains, in a general way, how your employer calculates the amount of allocated tip income. Second, you should ask your employer specifically how they calculated your allocated tips amount. Ask to see computer records, daily or weekly sales reports, or other information that would show your sales and your tip income. If your employer refuses to share this information with you, then you need to proceed very carefully, and start keeping your own daily records to protect yourself.

What to Expect from the IRS

The IRS loves to conduct tip audits. If you have allocated tips, and choose not to report the full amount of allocated tips on Form 4137, you will be getting a letter from the IRS. Be prepared to explain how you calculated your tip income, and show your daily tip record as evidence. If your unreported tips are pretty substantial, the IRS may impose a penalty of 50% of the Social Security and Medicare tax (Line 12).
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