For all of you working as a waiter or waitress, bartender, barista, valet, cabbie, pizza delivery driver, or any other job that involves getting paid in tips, I have a tip for you: declare, declare, declare!
Although it may be tempting to get tax-free money now, you will kick yourself later on. Here are the top three reasons why declaring your tips is not only the right thing to do, but also a good idea for your finances:
Avoid IRS Hassle
Let’s deal with the elephant in the room first. If you face an IRS audit and you haven’t declared your tips, they’ll find out, and you’ll need to come up with some answers.
Yes, the IRS knows all about wait staff out there (in fact, the IRS audits service employees more often than the average taxpayer). And when the IRS sees a waiter’s 1040 with no tips declared, the IRS knows you are full of something. (And I’m guessing it’s not the promise your parents always claimed you had.) An IRS auditor is a bad enough beast to begin with; you don’t want to give him any reason to think you are good food.
Improve Your Financial Planning
Tips add up. Even if you only make $40 a night and have four shifts a week, that’s an extra $8,320 a year. An extra eight grand a year makes a big difference if you’re paying down debt, thinking about a home loan, or just trying to save for the future. Trouble is, cash tips are easy to spend before you even realize you had them. A lunch here, a cocktail there, and soon all that cash has vanished.
Think what you could do if you put all of your tips into a high yield savings account, opened an IRA, or just paid down some debt. I know! It’s astounding what all that pizza and beer money amounts to.
The best thing to do: Keep your spending cash separate from your tips.
Once a week, take your tips to the bank and deposit them in a separate account. Once every other week or once a month, calculate how much to withhold from your taxes and transfer the rest of your tips to your primary checking account. Then, pay quarterly estimated taxes with tip money you’ve been setting aside. This way, your tips will help you achieve your financial goals, and you won’t owe taxes you can’t pay at the end of the year.
Look Better to Creditors
When you apply for a mortgage or an auto loan, lenders look at your income. All other factors being equal, the more you make, the more likely they’ll approve your application. So if you declare your tips now, your year-end earnings will look a lot better to lenders. And yes, you need to declare the tips, because from a lender’s perspective, if you can’t prove you earned it, you might as well have stayed home watching America’s Next Top Model and eating bonbons.
The Bottom Line
Whatever you do with your tip money, don’t spend it before you “count it”, and try not to leave it in a dresser drawer, either. It won’t do you any good unless you really do need to skip town at a moment’s notice, in which case I assume you laughed at the section on the IRS.
You will have to pay both state and federal taxes on any earned income declared, so make sure you are putting away a percent of your cash earnings in case you have to pay out at the end of the year. If you don’t know how to declare your tips, ask your employer. They’re required, by law, to provide you with information on how to declare cash income…something any good employer should be happy to help you do, anyway.