Taxing Tips

 Now that both major candidates have come out in favor of making tips tax exempt, I have to ask “why?”. Other than pandering to the powerful hospitality industry unions in Nevada.

Tips are income and are considered taxable – subject to income & payroll taxes. In the past, when tips were primarily given in cash, and IRS regulations were looser (or nonexistent) it was easier to avoid reporting some or all of them as income - but they've always been taxable income. With most payments now being made by card or app, virtually all tips go through the employer with income and payroll tax withheld from paychecks. Even with the dwindling number of cash tips, the IRS has been tightening reporting requirements.

There’s a myth that the IRS requires that employers assume that servers receive a certain percentage of the gross sales in tips and withhold income & payroll taxes on that amount whether or not they actually received that amount of tips. The IRS DOES mandate that employees report ALL tips to their employer and that the employer consider those taxes as income & withhold taxes accordingly. If the total reported tips for a business falls below 8% the employer is also required to allocate the difference between the actual percentage and 8% among all tipped employees. (This might be the origin of the myth) This shows up in a separate box on an employee's W-2. The employee must add this amount to the total gross income unless they can provide records to show that their actual tips were less. (Which is why keeping a tip record is important) 

What I do not think is legal is for an employer to assume that servers receive a certain percentage of the gross sales as tips and withhold income & payroll taxes accordingly. (No taxes are withheld from the allocated amounts) I understand that this happens, illegal or not, but I don’t know what recourse an employee has if it’s happening. Bottom line is that it’s not the responsibility of the employer to confirm that 100% of tips are being reported, their only responsibility is to remit the taxes that they collect based on wages plus reported tips .

I understand that employees who depend on tips are in a different boat than hourly or salaried employees. I’ve always known what my pay was going to be before going to work – a tipped employee never knows. But it’s still INCOME. I’d focus more on making those who derive their income from non-wage sources (dividends and so-called carried interest etc.) pay the same income tax rates as wage earners and remove the cap on social security taxes. And speaking of Social Security, if you artificially depress your income by not reporting tips, the amount of income that is used to calculate your eventually Social Security benefits will necessarily be much lower.