Taxing Tips

It was kind of fun trying to come up with a decent headline for today’s article.  Tips are in the news a lot, lately.  Servers, and others who receive tips, don’t like handing out a portion of their tips to other co-workers and especially not to the “house” (management).  Now, we find that they don’t like “tipping out” to the big house, either!  It’s not like we didn’t know this, but apparently, the CRA is just starting to take notice!

The CRA took a small sample of servers (145) at four restaurants in St. Catherines, Ontario, and conducted two-year audits of their personal tax returns, to see how much tip income had been reported.  Not very much, it seems.  Half of the servers didn’t report any tips at all.  On average almost $12,000 of tip income went unreported.  In total, $1.7 million of undisclosed income was found by CRA auditors.  You can read more about this in today’s Toronto Star article, Wait staff hiding tips from the tax man, auditors find.

Very interestingly, six months before the audits, the CRA sent out notices to servers and bartenders at 311 restaurants in the St. Catherines area, informing (warning) them that tip income must be reported.  Still, the amount of unreported tip income was rather staggering.  Apparently, the word on the street is that servers won’t get caught if they fail to report their tips, or under-report them.

This program was part of the CRA’s three-year investigation into fraud and tax evasion in the underground economy.  A lot of their effort was focused on the restaurant industry, because there is a high proportion of cash transactions.

So, what do these findings mean?  

The CRA knows that this is a fertile field that requires plowing.  The question is, who is going to do the plowing?  These individual audits must be pretty expensive to carry out, especially when the average income being evaded is only about $12,000.  While these types of audits send a message to other wannabe tax evaders, er, I mean servers, there’s still not much bang for the tax audit buck.  There must be a better way.

In the United States, the IRS requires employers to keep track of employee tip income and report it to the tax authorities.  While this creates a nasty piece of work for restaurant owners, who usually don’t receive any of this income, it is a very efficient way for the government to make sure tip income is being reported.  And, if the recordkeeping isn’t done properly, it’s much easier to go after a few restaurants than it is to audit hundreds of employees.    This is the where it is going, in Canada.  It’s just a matter of time, and given the number of recent media articles about tips, we can expect this to happen sooner, rather than later.

Recall from my earlier article, Tips on Tipping Policies, that the CRA has become much more aggressive in its attempt to hold restaurants responsible for tip income, where the tips are “controlled” (tip pooling, tip sharing, house tip-outs, automatic gratuities, etc…).  While there are defenses to the CRA position, it is an expensive proposition to take them on, and to date, no case has come before the courts on this issue.

If the crack-down continues and expands (looks likely), this could have pervasive effects on the restaurant industry.  As it is, most restaurants lose money, or make very little.  If tips are fully taxable (of course they are, but I mean if they really are fully taxable), servers won’t work for the current minimum wage, as they do now.  There will be incredible pressure to raise wages and/or attempt to work under-the-table.  Restaurants will have no choice but to raise prices to cover the additional costs.  But will they be able to do this in a depressed economy?

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