Understanding Form 4137: Social Security and Medicare Tax on Unreported Tip Income

IRS Form 4137 stands out as a critical document for many workers in the service industry.

This Form, titled "Social Security and Medicare Tax on Unreported Tip Income," plays a vital role in ensuring that income from tips is accurately reported and taxed.

Being a CPA since living memory, I've seen many clients overlook this form, leading to complications down the line.

So, what exactly is Form 4137, when and how to use it effectively?

Let’s dive in.

What is Form 4137?

Form 4137 is used by employees who receive tips as part of their income but have not reported all of these tips to their employer.

The primary purpose of this Form is to calculate the Social Security and Medicare taxes owed on unreported tip income.

This includes any allocated tips shown on your Form(s) W-2 that you must report as income.

Why is Form 4137 important?

The IRS requires that all income, including tips, be reported for tax purposes.

NB! Tips are subject to both Social Security and Medicare taxes.

By using Form 4137, you ensure that your Social Security record accurately reflects your total tip income, which is crucial for determining your benefits in the future.

What are taxable tips?

Taxable tips are any additional money received directly from customers, through electronic payment methods, or from other employees (via tip pools or sharing arrangements) over and above the standard charge for a service.

This includes:

• Cash tips received directly from customers.
• Tips from customers who leave a tip through electronic settlement or payment. This includes credit and debit card tips.
• Tips received from other employees under any tip-sharing arrangement.
• Service charges that are distributed to employees.

Tip reporting and taxation basics

Employees who receive tips as part of their income are required to report this income to their employer.

This is crucial because:

• Employers need to withhold income, Social Security, and Medicare taxes based on total earnings, which include both hourly wages and tip income.
• The IRS requires all tips to be reported on tax returns. NOTE! Unreported tips can lead to tax discrepancies and potential penalties.

What are allocated tips & how to report them?

Allocated tips are amounts that an employer assigns to an employee in addition to the tips they reported.

This usually occurs in industries where tipping is customary, such as restaurants and bars.

Employers allocate tips when the total reported tips for all employees fall short of a certain percentage of the establishment's gross receipts.

How to manage allocated tips on form 4137?

When completing Form 4137:

• Include any allocated tips shown in box 8 of your Form W-2.
• Add these allocated tips to your total unreported tips to calculate the correct Social Security and Medicare taxes owed.
• Remember, allocated tips are not included in box 1 of your Form W-2 and no tax is withheld from these tips.

When to use Form 4137?

Reporting requirements

You are required to file Form 4137 under the following circumstances:

1. Unreported Tips. If in any calendar month, you received cash and charge tips totaling $20 or more and did not report the full amount to your employer.

This includes tips received directly from customers, as well as those distributed through tip-sharing arrangements with other employees.

2. Allocated Tips on W-2. If your employer allocated tips to you, as shown in box 8 of your W-2.

These are tips that your employer estimated and assigned to you in addition to the tips you reported, typically based on a percentage of the establishment's total sales.

The $20 rule

The $20 rule is a threshold set by the IRS for reporting tips.

Here's how it works:

1. Separate Application for Multiple Employers. If you work for more than one employer, this $20 threshold applies separately to each job.

For instance, if you receive $15 in tips from one job and $30 from another in the same month, you would only need to report the tips from the second job.

2. Monthly Evaluation. The assessment of whether you've crossed the $20 threshold in tips is done on a monthly basis.

This means that each month's tips are considered independently when determining the need to report and potentially file Form 4137.
 

Form 4137 preview

How to complete Form 4137?

Completing Form 4137 involves several steps:

Line 1: Employer and tip information

For each employer, provide details about the employer and the amount of tips received and reported.

If you have more than five employers, attach additional forms or a statement with all required information.

Line 2 to line 4: Calculating unreported tips

• Line 2: Add up the total amount of tips received from all employers.
• Line 3: Sum up the total amount of tips you reported to your employers.
• Line 4: Subtract Line 3 from Line 2 to find the amount of unreported tips.

Line 5: Tips under $20

Report any tips under $20 for a calendar month on this line, as these are not subject to Social Security or Medicare tax.

Line 6 to line 13: Tax calculations

Follow the instructions to calculate the Social Security and Medicare taxes owed on your unreported tips.

These calculations involve applying specific tax rates to your unreported tips.

Penalties for not reporting tips

Failing to report tips can result in a penalty equal to 50% of the Social Security and Medicare taxes due on those unreported tips.

Pro tip! This penalty can be avoided if you can demonstrate that your failure to report was due to reasonable cause and not willful neglect.

Bottom line

Understanding when and how to use this Form 4137 is crucial for anyone working in a tip-based industry.

Proper reporting not only helps avoid penalties but also ensures that your Social Security records are accurate, impacting future benefits.