Tips: Can be a Taxing Matter

With the holidays upon us, naturally folks think about tipping.

In general, it's customary to tip people who reliably and faithfully served you all year long. It's a good idea to extend a gesture of thanks to people who make your life better, easier or safer in some way. Of course you want to recognize their service but you also want to do what's appropriate. So what are the guide lines? If you do plan to give tips this year, here is a guide on tipping.

But Don't Always Give Cash: When most folks think about tipping, they think cash is king. But it's not always appropriate to give cash to everyone on your list. Accepting cash tips may be in conflict with professional or ethical standards for folks like your lawyer, financial advisor or accountant. Also think about other situations where a cash tip is not appropriate. For example, what's the message when you give your child's teacher $25 cash? It may create the appearance of a payment for preferential treatment for your child.

Instead, consider taking up a collection with other parents to purchase a gift card for office supply or book store gift card. Also, keep in mind that postal employees and other federal employees are not allowed to accept gifts of cash. They are also prohibited from accepting gift cards or anything worth more than $20.

Tipping and Taxes: Remember that generally tips are not tax deductible. However, there is a possible exception. Donating school supplies may qualify as a charitable deduction. You can only deduct the amount/value of your contribution that is more than the value of the benefit that you or your dependents receive. In other words, if you give school supplies, you can only deduct the value of the supplies that do not benefit your child.

Another possible tax-deductible for some holiday gifts is for gifts given to the neighborhood police or fire department. An example of this is a gift to their widows and orphans fund.

If you receive tips, you need to report these as most tip income is taxable. Keep a daily tip record. But you don't need to report service charges that your employer adds to the bill. These are W-2 wages. You should report tips you receive to your employer, who will then withhold taxes and report the proper amount to Social Security. Doing this could boost the amount of Social Security benefits you may receive when you retire.

You may be exempt from reporting tips if it's not customary to tip for the service you provide. The IRS may be willing to concede that additional payments received for normal services may not be tips and may be tax-free gifts from the customer.

Ray Martin

View all articles by Ray Martin on CBS MoneyWatch»
Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.

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