Social Security Tips (W-2)
Social Security Tips (W-2) refers to the amount reported by an employee as tips to their employer, which are subject to social security tax. These tips are usually reported in box 7 of the W-2 form issued by the employer. They are part of the total wages captured on which Social Security and Medicare taxes are calculated.
Last updated: July 23, 2023 • 5 min read
What Is Social Security Tips (W-2)?
Social Security Tips (W-2) refers to the part of an employee's earned income from tips that is subject to Social Security tax. This is typically reported on box 7 of the W-2 form, which employers use to report wage and salary information for employees.
What Is the History of Social Security Tips (W-2)?
The history of Social Security Tips (W-2) can be traced back to the advent of Social Security itself, which was established in the United States in 1935 as part of President Franklin D. Roosevelt's New Deal. At its inception, Social Security was aimed at providing financial security for the elderly, but it has since expanded to include a wide variety of benefits including disability and survivor benefits.
The inclusion of tips in Social Security taxable income came later, as previously, tip income wasn't consistently reported or taxed. This raised issues of fairness, as many workers in service industries rely heavily on tips for their income. In 1965, the IRS began requiring employers to keep records of employee tip income, and the FICA (Federal Insurance Contributions Act) tax was extended to cover tips as well as wages.
The process for reporting tip income was formalized with the development of the W-2 form, which includes a specific box (box 7) for reporting allocated tips. This made it easier for employees to report their tip income and for employers to accurately withhold the correct amount for Social Security taxes.
How Do You Calculate Social Security Tips (W-2)?
The calculation for Social Security Tips (W-2) is based on the tips that an employee reports to their employer. In the United States, the Federal Insurance Contributions Act (FICA) requires that the employee's tips are subject to a 6.2% Social Security tax.
Here's how you'd typically calculate it:
First, the employee must record all tips they receive from customers. The sum of these tips is the total tip income.
The total tip income is then multiplied by 6.2% (the current rate for Social Security tax) to determine the amount of Social Security tax that should be withheld.
Please note, tips that aren't reported to the employer may not appear in Box 7 of the W-2 form, however, this doesn't exempt them from being taxable. The employee is responsible for keeping track of and reporting any tips that they don't report to their employer.
How Do Social Security Tips (W-2) and Medicare Wages (W-2) Differ in Taxation?
Social Security tips (W-2) and Medicare wages (W-2) are both subject to different taxation rates under the Federal Insurance Contributions Act (FICA).
Social Security tips are taxed at a rate of 6.2%, up to a maximum wage base ($142,800 in 2021).
Medicare wages, on the other hand, are taxed at a flat rate of 1.45%. Unlike Social Security, there is no wage base limit for Medicare taxes, which means all covered wages are subject to the tax. Furthermore, an additional Medicare tax of 0.9% applies to wages over a certain threshold ($200,000 for single filers in 2021).
While both are reported by the employer on the employee's W-2 form, they will appear in different boxes: Social Security tips are usually found in Box 7 while Medicare wages and tips are reported in Box 5.
How Do Social Security Tips (W-2) and Federal Income Tax Withheld Differ?
Social Security tips (W-2) refer to the portion of an individual's earned income from tips that is subject to Social Security tax, at a rate of 6.2% up to a certain income limit.
Federal Income Tax Withheld, on the other hand, is the amount that employers hold back from their employees' wages to pay directly to the government. The amount withheld varies and is based on considerations such as the employee's income, the number of dependents they're claiming, and their filing status. The rates at which income is taxed at the federal level are progressive and range from 10% - 37%.
These two items are seen in different boxes on an employee's W-2 form: Social Security tips usually fall under Box 7, while Federal Income Tax Withheld is reported in Box 2.
What Factors Influence the Amount of Social Security Tips Reported on a W-2?
Several factors can influence the amount of Social Security Tips reported on a W-2:
Amount of Tips Received: The primary factor is the actual amount of tips the employee receives. The larger the amount of tips, the larger the amount that will be reported.
Reporting Compliance: The level of reporting compliance by the employee also plays a role. Some employees may under-report their tip income, which would subsequently lower the amount reported on the W-2.
Employer Allocated Tips: In some cases, if an employee reports tips that are less than 8% of their sales, the employer must make up the difference and report it as "allocated tips." These allocated tips also count toward the Social Security Tips reported on the W-2.
Type of Employment: The type of employment and industry also plays a role. For instance, waitstaff, bartenders, and others in the service industry who regularly receive tips will often have a higher amount reported compared to those in industries where tipping is less common.
What Potential Drawbacks Might Employees Experience From Reporting Social Security Tips on a W-2?
The process of reporting Social Security Tips on a W-2 has a few potential drawbacks for employees:
Reduced Take-Home Pay: Since reported tips are subject to Social Security and Medicare taxes, an increase in reported tip income can result in a decrease in net take-home pay due to larger tax withholdings.
Record Keeping Burden: Employees are required to keep accurate records of all cash tips received each day which can be tedious and time-consuming.
Increased Tax Liability: With increased reported tip income, an employee's total taxable income rises, potentially putting them in a higher income tax bracket and meaning they'll owe more in taxes.
Audit Risk: If tips are not reported accurately, it may increase the risk of an audit by the IRS. If discrepancies are found between reported tips and actual tips earned, the employee could face penalties.
Which Employers Are Likely to Be Affected by Social Security Tips (W-2)?
Employers in the following industries are likely to be affected by Social Security Tips (W-2) as they commonly have employees who earn tips:
Food and Beverage Industry: Restaurants, cafes, bars, and other dining establishments where servers, bartenders, and bussers often earn tips.
Hospitality Industry: Hotels, motels, and inn services where staff, such as bellhops, concierge and housekeeping, may receive tips.
Personal Care Services: Hair salons, barbershops, spas, fitness trainers, and beauty parlors where employees often receive tips from clients.
Transportation Services: Taxi drivers, rideshare drivers (Uber, Lyft), and shuttle drivers often earn tips from passengers.
Entertainment Industry: Casino workers and tour guides can also earn a significant portion of their income from tips.
These employers are required to keep records of tip income and report it to IRS as part of their employees' wages. It's necessary for these employers to fully understand their responsibilities around reporting tip income to ensure compliance with the law and to avoid potential penalties.