So You Want To Be A Waiter

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Tag Archives: IRS

New IRS ruling explained by David Hayden

From David Hayden’s most excellent site, “The Hospitality Network”. David is also the author of a valuable book, “Tips2: Tips For Improving Your Tips“. The book is worth its weight in gold for servers who want to give themselves a raise.

David’s article is about a new IRS ruling regarding automatic gratuities (autograts).

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.

Tips for waiters about personal budgeting

The great blog, “Tips on improving your tips” (see ye olde blogroll for permalink) has a nice article on budgeting for waiters, which can be read here:

I just wanted to add one thing – it’s important for American waiters to always remember that for a vast majority of them, they’re going to owe taxes on April 15th.

For those who work in states that pay an hourly wage significantly lower than minimum wage, such as $2.13 – $4/hr, it’s especially important to remember this. Many of us don’t ever see a dime on our paychecks. But we don’t always remember that this is because we’re in the hole with income tax withholding and that each shift that we work puts us a little bit deeper in the hole.

I’ve written about this in the past, but it bears repeating – a good rule of thumb is to set aside 10% of tips for tax purposes. Money you never see is money that is saved and not spent.

This is easier said than done, as I can testify. It’s so easy to use that envelope full of cash for an emergency or some sort of impulse purchase. After all, it’s an envelope full of cash! It’s always whispering to you everytime you add to it.

But be strong. If you put aside 10% religiously, you might even find that you’ve got extra left over after you’ve fulfilled your tax obligations.

These days, you can make it easier to never see the money if you pay into the IRS’s EFTPS system. This is an electronic accont that you can access online. You can make deposits whenever you like. I talk about it more in depth here:

Another alternative to the cash-filled envelope is to open a separate savings account and try to avoid the temptation to plunder it. It might help when you see the amount grow “on paper”.

However you do it, budgeting for taxes is a very important part of a waiter’s budget decision-making process.

Why you should claim all of your tips

This post is certain to ruffle a lot of waiter feathers. So be it.

1. It’s the legal responsibility to do so. If your neighbor who gets paid by paycheck has to fully declare all of their income for tax purposes, then so should you. Don’t be like the cheap tipper who doesn’t tip anything other than 10% because “he doesn’t have to” or “she can get away with it”. They are getting a free ride on the backs of their fellow guests and anyone who hides their income from the IRS is getting a free ride in society on the backs of their fellow Americans. If a big corporation were discovered cheating on their taxes by illegally hiding income, I’m sure most waiters would be pissed off. I know I would be. That’s why it disturbs me that so many waiters are willing to display the same behavior. You can say all you want that taxes are too high or you don’t want your taxes going to war, or “why should I do it when no one else is” or “I have to pay taxes on income I don’t make when I get stiffed” (a common fallacy that’s not true 99% of the time) or “All the IRS is looking for is 8% (also a big fallacy). All of these are simply rationalizations for unacceptable behavior.

2. It hurts you when you go to get credit. Most credit lenders want verified income. You can’t verify what you don’t declare on your W-2. They aren’t going to take your word that you make X amount in tips just because you say so.

3. You’re screwing yourself on Social Security down the road. Social Security is based solely on the income that you report to the IRS. Sure, some of you young pups might not believe that Social Security is going to be around with you. But why take the chance?

4. You’re really not saving that much in taxes. At the tax rate that most servers are at, for every $1000 that you don’t declare, you’re saving about $150 at tax time. Sounds like a lot of money, but is it worth the problems you’ll have if you get randomly audited or your restaurant gets hit by the IRS? The IRS doesn’t release how they determine audits, but it’s well-known that they target certain industries known for tax irregularities. Think you’re possibly in one of those industries?

5. It gives ammunition to those few cranks who don’t believe in tipping. It gives them the justification for saying that tipping should be abolished. They say that we are greedy little creatures who don’t even declare all of our income, so why should they subsidize that sort of behavior? Plus, they use it to justify their ideas that it should be the responsibility of restaurants to pay us so that we have to pay our taxes just like everyone else.

6. It reinforces the idea that tips are merely “gifts” from the guest. I’ve actually seen that idea tossed around and it drives me crazy. First of all, a tip is not a gift. It’s a payment for services rendered. A gift isn’t taxable up to $13,000 (in 2009) a year from a single source. And all payments for services rendered are considered ordinary income.  Don’t give the wackos justification for this sort of view of tips.

Waiters (or any tipped employees) really don’t have any real excuse for not declaring their all income. We can rationalize all we want, but the bottom line is, it’s just the right thing to do. And it really is in the server’s best interest to do so. It’s just not worth all of the machinations or trying to figure out how much to declare. Just count the money in your pocket at the end of the shift after tipout. That’s your income. That’s what you should declare.

The only exception to this is if your restaurant demands that you declare a certain amount and they do it for you. Sometimes, they have agreements with the IRS to have all of their servers to declare a certain percentage of their sales and, in that case, you’re sort of locked into a figure. This is the IRS trying to capture a larger percentage of income through a sort of amnesty in a way. They say that if the restaurant signs an agreement, they agree not to audit the restaurant unless there is a serious discrepancy with future declared tips. They usually set a baseline based on past business. If your restaurant is having you declare 8% of your sales, they probably don’t have such an agreement with the IRS. The IRS surely will make them have you tip out at least 10% of sales because, let’s face it, if you’re not consistently making 10% after tipout, something is seriously wrong. In the old days, and by old days I mean pre-1995, 8% was what the IRS considered a minimum declaration and many servers and restaurants did the minimum. However, it ended up biting some waiters in the ass at audit time because the IRS would have the restaurant pull credit card receipts and compare them to what was being declared. Guess what the result would be? I know one waiter who got nailed for a $10,000 back taxes bill (that included fees and penalties).  So, dismiss any talk of 8% when it comes to what you should declare for your tipout. that’s old old stuff. The IRS is clear, despite them making a few compromises through such things as TRAC agreements and the like, they are clear. You must declare all of your income. 

And, before you ask, yes, I declare down to the dollar. I use the standard rounding technique that the IRS allows on their tax return. If it’s .49 or less, I round down, .50 or above, I round up.

10% a waiter can get behind

Many waiters, especially new ones, don’t think about the fact that most waiters will owe money on April 15th to the IRS. Those of us who do tend to block it out throughout the year.

Why do we owe money at tax time? Why is a refund out of the question for most waiters?

The only place that tax withholding can take place for most servers is through the hourly wage. If you’re in a state that allows restaurants to pay you $2.13 an hour, you not only get $0.00 paychecks, you might not realize that you’re in the hole for withholding. In fact, the more tips you make, the further in the hole you get because the less taxes get withheld for that amount of income. The other thing that works against you is that Medicare and Social Security get taken out first. Whatever is left over is earmarked for Federal Income Tax withholding.

Here’s an example from my most recent paycheck (covers a two week pay period):

Tips: $1321.30

Hours at $2.13/hr  51.53 hours  $109.76

Training hours $6.55/hr (we get paid for mandatory meetings) 2 hours $13.10

I had a total of $122.86 in hourly wages.

Medicare – $20.73

Social Security – $89.54

Federal – $12.59!

As you can see, I ran out of hourly money. I was only able to get about 1% of my income withheld. Since most of us are going to owe between 10% – 15% of our gross wages after all deductions, it’s no surprise that most of us are going to owe between $1000 – $4000 at tax time. 

So now we come to the 10% figure quoted in the subject header.

Let’s say you make a hundred bucks in a shift. You should take a $10 bill from your wad of cash (or 10 ones if you want, but I’d save those for tomorrow’s bank) and put it in an envelope. If you make $40, put $4 aside. If you’re one of the rare people who can put money aside and not touch it during lean times, you’ll find that at the end of the year, you’ll have pretty close to what you need to pay the government. However, if you’re like the rest of us, you’ll probably want to make estimated quarterly payments to the IRS. You can call their hotline or go on line to get all of the details. They even have a new system of on-line electronic payment called EFTPS. You can literally make payments every single day if you want. You can even assign payments to specific years, but be careful – sometimes it’s hard to keep track of where you’ve put your money. The worst thing you can do, other than doing nothing, is to co-mingle that money with the rest of your money. Sure…you’re going to make a payment to the IRS next week from your bank account. Sure…you’ll put 20% in next shift because you want to have drinking money tonight. Right. Been there, done that.

Which brings us to “pay me first”. If you take the money and segregate it immediately, you won’t miss it or blow it when you go out with your friends.

I haven’t addressed those who live in states that require actual minimum wage like Washington State, California and the like (or states in the middle that pay $4 an hour). Not being privy to the actual figures, I can’t speak to specifics, but I’d suspect that it would be handy for waiters in those states to at least put aside 5% for taxes.

I also can’t speak to the specifics of those waiters who get paid by paycheck instead of taking money home with them daily. I’d assume that your withholdings are covered, but you need to ask your management. Or, you could look on your paycheck and if you see figures in the withholding block like the ones I quoted from mine, you can probably assume that you’re also not getting enough withholding taken out.

Finally, this is one reason that I chuckle to myself when I, or anyone else says, “I made $100 last night”. Not really – you only made $90. You should start getting in the mindset of mentally subtracting 10% from what you think you make. It’ll save your ass at tax time.

Just ask me.  I’ll tell you what a bummer it is to be paying the IRS $75 a month for last year’s taxes and having to pay an extra couple of hundred bucks in fees and penalties above what i would have owed. Yep, even old guys sometimes don’t ever learn.