You can’t beat the feeling of an illegal u-turn. It’s the same rush you get when you ask for a water cup but then fill it with coke instead. Similarly, not reporting your cash tips can feel exhilarating and edgy, like channeling your inner Al Capone (minus, yunno, the mob-boss part).
While not reporting tip income might seem as innocent as swiping a 50 cent soda, it can get you into serious trouble with Uncle Sam. The IRS mandates that you properly record and report all tip income, including cash. To understand this better, let’s look at both stipulations individually and then discuss what happens if you don’t report your tips:
Recordkeeping - Maintain a Tip Log.
This is a basic recordkeeping requirement. The IRS expects you to maintain good records for all your business income and expenses, and tips are no exception. However, since most of your tip income can be tracked through your bank statements & receipts, all you really need to worry about are those minty greens.
To that end, best practice is to keep a log. The IRS doesn’t require you to track your tips this way, but recommends that your log shows the date you received the tip, the payment method (credit card, cash, check), and how much it was for. They even developed an easily accessible form for taxpayers to use.
Reporting - Include Your Tips on Your Taxes.
That’s it really. Not much to expound on here. Just include your cash tips with your other business income.
I will take this opportunity to say, if you have employees who work for you and earn tips, you MUST pay payroll taxes (social security & medicare) on those tips when you run payroll. And it’s a serious no-no to earn cash tips and NOT report them to your employer. You can get yourself (and your boss) in a lot of trouble.
OK. You forgot to report your cash tips. Are you going to jail?
Take a breather. You’re not Al Capone yet. At worst, here’s what you’re looking at: a 50% penalty on the late FICA taxes (social security & medicare), a 25% penalty (at most) on late income taxes, and any additional interest. Note: these penalties are only assessed if you actually owe tax. If your company had a loss, and the additional tip money isn’t enough to turn the loss into a profit, you’re fine. You won’t owe any tax or penalties.
Furthermore, the IRS (only) has 3 years from the time you file your return to audit it. Once those three years are up, the return is closed and can’t be audited (in most circumstances). Additionally, the IRS generally has no way of telling whether or not you reported your cash tips. After all, the beauty of cash is that it leaves no paper trail, so how can they prove you ever received it? But before I stray into the realm of aiding and abetting tax fraud, let me remind everyone: NOT REPORTING INCOME IS A CRIME.
Bottom Line: Now that you know better, report your tips. But I wouldn’t bother amending a return you filed last year because you forgot to report $200. As long as it’s not substantial money, the IRS doesn’t care, and neither should you.