My employer does not take tax from my wages, but they are taking taxes out of my tips. Is this correct?
Claiming “exempt” on your W-4 form prevents your employer from withholding federal income tax from both your wages and your tips. Depending on which state you live in, I suppose you could also claim “exempt” there too and your employer would not withhold state income tax from your wages and tips.
Wages and tips are both treated equally in the eyes of the feds and the states. They are both considered earned income subject to income tax, social security tax, and medicare tax. The last two are collectively referred to as FICA.
This FICA tax (which is 6.2% + 1.45% or a total of 7.65%) is taxed on all earned income regardless of what you put on your W-4 form. Your employer is required to withhold this FICA tax on both your earnings and your tips. In addition, your employer contributes an additional 7.65% to FICA. So, FICA gets 15.3%, half from your wages, half from your employer. There is nothing within the law you can do to prevent this from being collected. It is being set aside for your retirement and medical costs.
Like the others have said, be absolutely certain you are allowed to file as “exempt” on your W-4. Filing “exempt” when you are not allowed to file “exempt” can cause problems. If you normally get a refund due to EITC or Child Tax Credits and you don’t want anything being withheld from your pay, it can be better to file Married 5 or something similar. As long as your pay is low, no federal income tax will be withheld, and you won’t have to worry about getting into trouble filing “exempt”.