Other Sickness and Injury Benefits

In addition to disability pensions and annuities, you may receive other payments for sickness or injury.

Railroad sick pay.   Payments you receive as sick pay under the Railroad Unemployment Insurance Act are taxable and you must include them in your income. However, do not include them in your income if they are for an on-the-job injury.

If you received income because of a disability, see Disability Income, earlier.

Federal Employees' Compensation Act (FECA).   Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. However, you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Report this income on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ. Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages.

If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see Other Income under Miscellaneous Income, later.

You can deduct the amount you spend to buy back sick leave for an earlier year to be eligible for nontaxable FECA benefits for that period. It is a miscellaneous deduction subject to the 2% limit on Schedule A (Form 1040). If you buy back sick leave in the same year you use it, the amount reduces your taxable sick leave pay. Do not deduct it separately.

Other compensation.   Many other amounts you receive as compensation for sickness or injury are not taxable. These include the following amounts.

• Compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments.
• Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your income.
• Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy.
• Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement. This compensation must be based only on the injury and not on the period of your absence from work. These benefits are not taxable even if your employer pays for the accident and health plan that provides these benefits.

Reimbursement for medical care.   A reimbursement for medical care is generally not taxable. However, this reimbursement may reduce your medical expense deduction. For more information, see chapter 23.

Tip Income

Introduction

This chapter is for employees who receive tips from customers.

All tips you receive are income and are subject to federal income tax. You must include in gross income all tips you receive directly from customers, tips from charge customers that are paid to you by your employer, and your share of any tips you receive under a tip-splitting or tip-pooling arrangement.

The value of noncash tips, such as tickets, passes, or other items of value are also income and subject to tax.

Reporting your tip income correctly is not difficult. You must do three things.

1. Keep a daily tip record.
2. Report tips to your employer.
3. Report all your tips on your income tax return.

This chapter will show you how to do these three things and what to do on your tax return if you have not done the first two. This chapter will also show you how to treat allocated tips.

Useful Items You may want to see:

Publication

• 531   Reporting Tip Income
• 1244   Employee's Daily Record of Tips and Report to Employer

Form (and Instructions)

• 4137   Social Security and Medicare Tax on Unreported Tip Income
• 4070   Employee's Report of Tips to Employer

Keeping a Daily Tip Record

Why keep a daily tip record?   You must keep a daily tip record so you can:

• Report your tips accurately to your employer,
• Report your tips accurately on your tax return, and
• Prove your tip income if your return is ever questioned.

How to keep a daily tip record.   There are two ways to keep a daily tip record. You can either:

1. Write information about your tips in a tip diary, or
2. Keep copies of documents that show your tips, such as restaurant bills and credit card charge slips.

You should keep your daily tip record with your personal records. You must keep your records for as long as they are important for administration of the federal tax law. For information on how long to keep records, see Publication 552, Recordkeeping for Individuals.

If you keep a tip diary, you can use Form 4070A, Employee's Daily Record of Tips. To get Form 4070A, ask the Internal Revenue Service (IRS) or your employer for Publication 1244. Publication 1244 includes a year's supply of Form 4070A. Each day, write in the information asked for on the form.

If you do not use Form 4070A, start your records by writing your name, your employer's name, and the name of the business if it is different from your employer's name. Then, each workday, write the date and the following information.

• Cash tips you get directly from customers or from other employees.
• Tips from credit card charge customers that your employer pays you.
• The value of any noncash tips you get, such as tickets, passes, or other items of value.
• The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees to whom you paid the tips.

Do not write in your tip diary the amount of any service charge that your employer adds to a customer's bill and then pays to you and treats as wages. This is part of your wages, not a tip.

Electronic tip record.   You may use an electronic system provided by your employer to record your daily tips. You must receive and keep a paper copy of this record.

Reporting Tips to Your Employer

Why report tips to your employer?   You must report tips to your employer so that:

• Your employer can withhold federal income tax and social security and Medicare taxes or railroad retirement tax,
• Your employer can report the correct amount of your earnings to the Social Security Administration or Railroad Retirement Board (which affects your benefits when you retire or if you become disabled, or your family's benefits if you die), and
• You can avoid the penalty for not reporting tips to your employer (explained later).

What tips to report.   Report to your employer only cash, check, or credit card tips you receive.

If your total tips for any one month from any one job are less than $20, do not report them to your employer.

Do not report the value of any noncash tips, such as tickets or passes, to your employer. You do not pay social security and Medicare taxes or railroad retirement tax on these tips.

How to report.   If your employer does not give you any other way to report tips, you can use Form 4070. To get a year's supply of the form, ask the IRS or your employer for Publication 1244. Fill in the information asked for on the form, sign and date the form, and give it to your employer.

If you do not use Form 4070, give your employer a statement with the following information.

• Your name, address, and social security number.
• Your employer's name, address, and business name (if it is different from the employer's name).
• The month (or the dates of any shorter period) in which you received tips.
• The total tips required to be reported for that period.

You must sign and date the statement. You should keep a copy with your personal records.

Your employer may require you to report your tips more than once a month. However, the statement cannot cover a period of more than one calendar month.

Electronic tip statement.   Your employer can have you furnish your tip statements electronically.

When to report.   Give your report for each month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give your employer the report by the next day that is not a Saturday, Sunday, or legal holiday.

Example 1.   You must report your tips received in June 2003 by July 10, 2003.

Example 2.   You must report your tips received in April 2003 by May 12, 2003. May 10th is on a Saturday, and the 12th is the next day that is not a Saturday, Sunday, or legal holiday.

Final report.   If your employment ends during the month, you can report your tips when your employment ends.

Penalty for not reporting tips.   If you do not report tips to your employer as required, you may be subject to a penalty equal to 50% of the social security and Medicare taxes or railroad retirement tax you owe on the unreported tips. (For information about these taxes, see Reporting social security and Medicare taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, later.) The penalty amount is in addition to the taxes you owe.

You can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, attach a statement to your return explaining why you did not report them.

Giving your employer money for taxes.   Your regular pay may not be enough for your employer to withhold all the taxes you owe on your regular pay plus your reported tips. If this happens, you can give your employer money until the close of the calendar year to pay the rest of the taxes.

If you do not give your employer enough money, your employer will apply your regular pay and any money you give to the taxes in the following order.

1. All taxes on your regular pay.
2. Social security and Medicare taxes or railroad retirement tax on your reported tips.
3. Federal, state, and local income taxes on your reported tips.

Any taxes that remain unpaid can be collected by your employer from your next paycheck. If withholding taxes remain uncollected at the end of the year, you may be subject to a penalty for underpayment of estimated taxes. See Publication 505, Tax Withholding and Estimated Tax, for more information.

Uncollected taxes. You must report on your tax return any social security and Medicare taxes or railroad retirement tax that remained uncollected at the end of 2002. See Reporting uncollected social security and Medicare taxes on tips under Reporting Tips on Your Tax Return, later. These uncollected taxes will be shown in box 12 of your 2002 Form W-2 (codes A and B).

Tip Rate Determination and Education Program

Your employer may participate in the Tip Rate Determination and Education Program. The program was developed to help employees and employers understand and meet their tip reporting responsibilities.

There are two agreements under the program - the Tip Rate Determination Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). In addition, employers in the food and beverage industry may be able to get approval of an employer-designed EmTRAC program. For information on the EmTRAC program, see Notice 2001-1 in Internal Revenue Bulletin No. 2001-2 (or Cumulative Bulletin 2001-1).

Your employer can provide you with a copy of the agreement. If you want to learn more about these agreements, contact the local tip coordinator. A list of tip coordinators is available at www.irs.gov.

Reporting Tips on Your Tax Return

How to report tips.   Report your tips with your wages on line 1, Form 1040EZ, or line 7, Form 1040A or Form 1040.

What tips to report.   You must report all tips you received in 2002, including both cash tips and noncash tips, on your tax return. Any tips you reported to your employer for 2002 are included in the wages shown in box 1 of your Form W-2. Add to the amount in box 1 only the tips you did not report to your employer.

If you received $20 or more in cash and charge tips in a month and did not report all of those tips to your employer, see Reporting social security and Medicare taxes on tips not reported to your employer, later.

If you did not keep a daily tip record as required and an amount is shown in box 8 of your Form W-2, see Allocated Tips, later.

If you kept a daily tip record and reported tips to your employer as required under the rules explained earlier, add the following tips to the amount in box 1 of your Form W-2.

• Cash and charge tips you received that totaled less than $20 for any month.
• The value of noncash tips, such as tickets, passes, or other items of value.

Example.   John Allen began working at the Diamond Restaurant (his only employer in 2002) on June 30 and received $10,000 in wages during the year. John kept a daily tip record showing that his tips for June were $18 and his tips for the rest of the year totaled $7,000. He was not required to report his June tips to his employer, but he reported all of the rest of his tips to his employer as required.

John's Form W-2 from Diamond Restaurant shows $17,000 ($10,000 wages plus $7,000 reported tips) in box 1. He adds the $18 unreported tips to that amount and reports $17,018 as wages on his tax return.

Reporting social security and Medicare taxes on tips not reported to your employer.   If you received $20 or more in cash and charge tips in a month from any one job and did not report all of those tips to your employer, you must report the social security and Medicare taxes on the unreported tips as additional tax on your return. To report these taxes, you must file a return even if you would not otherwise have to file. You must use Form 1040. (You cannot file Form 1040EZ or Form 1040A.)

Use Form 4137 to figure these taxes. Enter the tax on line 57, Form 1040, and attach Form 4137 to your return.

Reporting uncollected social security and Medicare taxes on tips.   If your employer could not collect all the social security and Medicare taxes or railroad retirement tax you owe on tips reported for 2002, the uncollected taxes will be shown in box 12 of your Form W-2 (codes A and B). You must report these amounts as additional tax on your return. You may have uncollected taxes if your regular pay was not enough for your employer to withhold all the taxes you owe and you did not give your employer enough money to pay the rest of the taxes.

To report these uncollected taxes, you must file a return even if you would not otherwise have to file. You must use Form 1040. (You cannot file Form 1040EZ or Form 1040A.) Include the taxes in your total tax amount on line 61, and write UT and the total of the uncollected taxes on the dotted line next to line 61.

Allocated Tips

If your employer allocated tips to you, they are shown separately in box 8 of your Form W-2. They are not included in box 1 with your wages and reported tips. If box 8 is blank, this discussion does not apply to you.

What are allocated tips?   These are tips that your employer assigned to you in addition to the tips you reported to your employer for the year. Your employer will have done this only if:

• You worked in a restaurant, cocktail lounge, or similar business that must allocate tips to employees, and
• The tips you reported to your employer were less than your share of 8% of food and drink sales.

How were your allocated tips figured?   The tips allocated to you are your share of an amount figured by subtracting the reported tips of all employees from 8% (or an approved lower rate) of food and drink sales (other than carryout sales and sales with a service charge of 10% or more). Your share of that amount was figured using either a method provided by an employer-employee agreement or a method provided by IRS regulations based on employees' sales or hours worked. For information about the exact allocation method used, ask your employer.

Must you report your allocated tips on your return?   You must report allocated tips on your tax return unless either of the following exceptions applies.

1. You kept a daily tip record, or other evidence that is as credible and as reliable as a daily tip record, as required under rules explained earlier.
2. Your tip record is incomplete, but it shows that your actual tips were more than the tips you reported to your employer plus the allocated tips.

If either exception applies, report your actual tips on your return. Do not report the allocated tips. See What tips to report under Reporting Tips on Your Tax Return, earlier.

How to report allocated tips.   If you must report allocated tips on your return, add the amount in box 8 of your Form W-2 to the amount in box 1. Report the total as wages on line 7 of Form 1040. (You cannot file Form 1040EZ or Form 1040A.)

Because social security and Medicare taxes were not withheld from the allocated tips, you must report those taxes as additional tax on your return. Complete Form 4137, and include the allocated tips on line 1 of the form. See Reporting social security and Medicare taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, earlier.

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