So You Want To Be A Waiter

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Article about tips, taxes and the IRS at Tip20! (the exclamation point is part of the blog’s title).

This article is generally OK but still perpetuates some myths about how the IRS deals with tips and taxes.

They are correct that the IRS will use credit card slips to determine whether cash tip reporting is accurate (see below)

However, they miss the mark when it comes to the old 8% reporting standard.

“8% is simply a bottom line that the IRS uses when attempting to determine how much a server earned in tips over the year”.

Well, not exactly. They don’t treat anything automatically as taxable income. They only treat tip income taxable income as reported by the waiter and the restaurant. 8% is a vestige from years ago when they weren’t looking as closely at what tipped employees were tipping and 8% was “routinely” reported without incident. Around 15 years ago, they realized that tipped employees were underreporting and that they were losing out on taxes, so they got aggressive about requiring accurate reporting from tipped employees.

“What it means is that in the absence of documentation to show how much that server earned in tips the IRS is going to assume that they earned at least 8% of their food and beverage sales. So if a server sells $1,000 of food than the IRS is going to automatically assume that they took home $80 in tips that night. They’re going to treat that $80 as taxable income and depending on what tax bracket the server is in they might get 25% of the $80 which is $20. So when a customer tips 8% it isn’t all going to the government, it’s simply that all of it is going to be taxable automatically”.

The IRS doesn’t reveal what can cause red flags that could trigger audits. They don’t give away the percentages that they expect to see either. They really don’t make assumptions about any particular percentage per se. Besides, many restaurants have signed TRAC or TRDA agreements, which are blanket tip reporting documents that require restaurants to establish baseline reporting standards. We’ll get back to tip percentages in a minute.

“Most service employees average 15-20% of their sales in tips, so using 8% as a default is conservative from the IRS’s point of view”.

The IRS doesn’t have a “default” tip percentage anymore. As I said, 8% is a vestige of the old days. As far as I know, 8% is meaningless. They obviously have percentages that they expect to see and they aren’t talking, but people “in the know” seem to think that they have a range of tips that they might expect to see.

“In places where credit cards are used the IRS can use the tips on charged receipts to estimate the amount of tips received from tickets paid in cash. The two are generally close to each other, so if a server shows 16% of tips on all of the charged receipts they’ll be sending up a red flag if they under declare their cash tips too drastically (e.g. 6%)”.

I might be wrong about this, and I’m not a tax attorney, but if the IRS is looking at a particular waiter’s credit card receipts, there is no “red flag”, there is only an audit. You aren’t sending up a red flag, you are basically holding yourself liable for penalties and accrued interest in the event of an audit if you are drastically underreporting your cash tips. Now, it’s certainly possible that a restaurant itself gets audited and a waiter might get caught in that net. But that’s a little different from what the above statement implies, that the IRS is randomly checking individual tipped employees. I don’t think that this happens (correct me if I’m wrong on this).  If a whole restaurant’s figures are way off in terms of what is the “industry norm” that they have themselves determined, at that point, you will probably see an audit. And, as I point out elsewhere, a waiter could conceivably get caught in a net if a restaurant has to go under the knife. Perhaps this is the point that Tip20! was trying to make.

“Still when a server is stiffed they are still losing money – they’re getting zero on a ticket that the IRS will assume they made at least 8% on, paying taxes on revenue they didn’t make”.

Not true. The IRS doesn’t look at an individual table, it looks at the big picture. While a stiff minutely drags down the general tip percentage, it is irrelevant to the IRS. The IRS isn’t going to tack on additional “income” that it assumes you made on that stiffed table. While it’s a good idea to note such tables on a tip report, if you are reporting your cash tips fairly, a stiff on its own won’t raise any “red flags”, nor will it add to your tax burden. Where a waiter loses money on a stiff is if they still have to tip out on those sales. Then they’ve actually paid money to wait on that table.

Here’s what’s true:

“Servers are required to report ALL of their tips, even if they made 25% (or more) of their sales in tips”.

It’s also true that in the unlikely event that every table in a shift stiffed you, you are required to report ZERO tips. You are required to report what you actually make, not an estimate of what you make or report income that you didn’t actually make (which is why you get to deduct your tipouts to other tipped employees).

However, this is complicated by the fact that some restaurants do actually have a “set percentage” that you can’t report below because they have a TRAC or TRDA agreement with the IRS. This means that you could conceivably end up reporting income that you didn’t make if you have a very bad night and don’t meet the threshold that the restaurant requires. I worked in a restaurant that required at least 10% of your income after tipout regardless of what you actually made. I think that I actually got hit with reporting 10% once when I actually only made 9.8% after tipout. Our tipout was around 7% of the tip percentage and that one night, I didn’t quite make 17% in actual tips. I could have probably made an issue of it, but .2% wasn’t worth making a fuss over. However, being someone who reports all of their income, I wouldn’t routinely report more than I actually made. Most restaurants set the bar so high that except fo a weird situation such as the one that I mention, it will never be an issue. And I’m pretty sure that I could have reported 9.8% without any problem had I demanded it (especially since I had no cash tables that night). I would have simply documented that these were my true tips. Since I usually reported 11-13% or more of my tips after tipout (I usually averaged 18 – 20% over the whole shift), my reporting far exceeded the “minimum”.

There’s a good reason for reporting all of your tips. In the event of an audit, you can rest easy and not have to worry about the occasional shift where your tip percentages were lower. The IRS is going to pull a pretty large representative sampling of your credit card slips. and they’ll take the lower percentages with the larger and determine a “real” percentage. I know of one waiter/bartender back in the 90s who ended up owing over $18k in back taxes, penalties and interest. Once they figured out that he was severely underreporting, during a certain period, they went back three years! That was enough for me to just simply report what I make. It’s not worth it for me to save a few bucks in taxes to risk getting nailed for a large back taxes bill.

Please note that I am not giving legal or accounting advice and that I don’t specialize in the tax enforcement strategies of the IRS. The waters have been muddied a bit with the advent of tip compliance programs, but I’m pretty sure that what I’ve written here is fairly accurate and applicable to most of my readership.

I welcome any credible corrections to what I’ve written, especially since it’s been years since I’ve had to deal directly with TRAC agreements (they started coming in during the last year or two of my managerial career).

Uncle Sam wants give him coins.


4 responses to “Article about tips, taxes and the IRS at Tip20! (the exclamation point is part of the blog’s title).

  1. Ashley February 19, 2011 at 4:25 pm

    Thanks for the information, very helpful!

  2. WVUCavalier March 11, 2011 at 1:17 am

    I have a question as to your the highly unlikely “bad night” scenario. I’ve worked part-time as a bartneder at a casino for several years. I’ve been good about reporting tips. However, I’ve got a strange hypothetical for you. At this casino, recently some bartenders have been required to sell additional items that do not customarily require tips and there are a very high volume of these items that we sell. Essentially, we basically selling items like magazines and newspapers. However, in our sales reports, everything is listed under food and beverage items. Our tippable income is only 3-5% of our food and beverage sales. I’m concerned that even reporting 100% is not sufficient in this case.

    • teleburst March 11, 2011 at 9:07 am

      I’m a little confused. Are you saying that of all of your sales, only 3-5% of your sales are actually food and beverage and the rest of the sales are actually things that you don’t get tipped on? If so, I would definitely ask the casino to separate these items from your actual tippable sales by creating a merch category or non-food category in the POS. Failing that, I’d document all non-food/beverage sales in a log. Many tipped employees don’t realize that the IRS actually requires a log kept by the employee. This is separate from whatever tip tracking sheet that the business requires to be submitted. The thing you want to be able to establish is that you are selling X amount of non-tipped-on goods. Waiters have the same problem when it comes to selling gift cards and other merchandise that the restaurant sells. Usually, for waiters, it isn’t a significant amount on any particular shift. When it is, the waiter should definitely document it. In the case of an audit, this will establish proof of non-tipped sales, which can then be backed up by the actual check, which most restaurant require to be turned in and which they keep in the “archives”.

      It’s all about making it easy for the IRS to establish tipped sales from non-tipped sales in the event of an audit.

      Keep in mind one thing though – you still have to report any tips that are earned on these things if they occur. As we know, patrons sometimes tip on these things when they show up on the check. You can’t automatically just say that just because there are some magazines on a check that you weren’t tipped on them, especially if the tip falls in a normal range. In other words, let’s say you have a bill for 4 drinks and 4 magazines. The 4 drinks are $40 and the magazines are $10. The bill is $50 and the patron tips $10. To do the right thing, you must report the entire tip, not just $8, which is 20% of the drink total. I’m assuming here that you have the intent to report all of your tips.

      The minimum wage thing doesn’t really factor into how you report your tips except that you are entitled to a tip credit if your income including tips and hourly doesn’t reach minimum wage. At that point, your restaurant must make up the difference. But, as far as I know, we’re not talking about a single shift. In other words, the restaurant doesn’t have to make up the difference if you come in for a couple of hours at $2.13/hr and leave early without serving anyone. I haven’t been able to find out anything definite about this, but I assume that it must be over a pay period. Don’t quote me on that though.

  3. WVUCavalier March 11, 2011 at 1:18 am

    Furthermore, we are paid less than minimum wage.

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