No matter who you are, if you visit establishments where tipping is allowed (or even expected), you may have heard that it’s better to tip in cash. Is it true? The answer may surprise you.
Tipping in cash is neither good nor bad, but it enables workers to mistakenly harm themselves, and it can also negatively impact you. Let’s talk about how this can happen.
At CSI Accounting & Payroll, we’ve worked with small business taxes for over 50 years. We’ve heard a lot of small business owners ask about the implications of cash tips in their workplace, including:
- Is it better to tip in cash?
- Are cash tips taxable?
- Do workers have to claim cash tips? What if they don’t report them?
Are Cash Tips Better?
The only real benefit of cash tips is that the worker may get to keep the money right away. With credit card tips, some employers hold the money until the next pay cycle so they can be taxed, meaning the worker may have to wait a couple of weeks.
However, the real reason why most people want to leave cash tips is for tax purposes – and depending on which form of tipping, there may be some tax concerns. There are two main forms of tipping: directly and indirectly (also called pooled tipping).
Direct Tipping
You may want to leave a cash tip if you are served by a worker – even if you paid the bill with your credit card. Does this benefit the worker more than credit card tips? Not really.
Why is that? Well, whether you leave a tip on your card or a cash tip, they’re still worth the same amount. However, a cash tip means no paper trail, allowing the worker to hide the money from the government and avoid paying taxes on it.
Not claiming the tip means they get more money, but this practice is both illegal and harmful to the worker if they ever need government benefits. (We’ll talk about that more in the following sections!)
Indirect or Pooled Tipping
For establishments with pooled tips (like a tip jar), all tippable positions working the same shift split the money.
Not every business will do this, but some will take cash tips and distribute them to workers via checks or direct deposit.
If that happens, then there is a paper trail, and taxes are paid. Then there are no issues!
What Taxes Come out of Cash Tips?
Tips should be taxed, whether they’re from a credit card or cash, but cash tips allow workers to hide the money and illegally avoid paying taxes.
Credit card tips or claimed direct cash tips are subject to the same taxes as any other income. This includes workers and their employers paying these taxes:
- Social Security
- Medicare
- Federal income tax
- State and local income tax, if applicable
Depending on the worker’s location, wages, hours, and tips earned, you can expect about a quarter of their tips to go to taxes.
Employers also pay federal and state unemployment tax based on their employees’ total wages – including tips. If employees aren’t reporting tips, their employer puts less into their employment benefits.
Workers Not Reporting Cash Tips
Here’s the thing about workers not reporting cash tips; the government knows. For example, they expect restaurants to have about 20 percent of food sales as claimed tips. If they suspect tips aren’t being claimed, they can impose negative consequences on the employee and their employer.
Plus, the U.S. has a huge tax gap between what is owed to the government versus what is actually paid. To help close this tax gap, unpaid taxes are covered by everyone else – just like you and me.
On the other hand, the government can also reward employers for enforcing direct tip reporting via the FICA tip tax credit. This is a great tax-saving opportunity.
Employees also benefit when they report their tips and pay their taxes, since they can claim more government benefits. After all, imagine dodging taxes only to have no Social Security to collect when you retire! Having about a quarter of your tips go to these funds can really help you out in the future.
Report Cash Tips and Reap the Benefits!
If you’re a small business owner and want to learn more about how tipped establishments can benefit tax-wise, consider partnering with an accountant for a year-round tax strategy and claim tax credits (like the FICA tip credit).
Now that you know why it’s not necessarily beneficial to tip in cash, how cash tips are taxed if claimed, and the consequences of not claiming them, are you ready to check out monthly accounting services?
If so, please consider CSI Accounting & Payroll! To see if we can be a good fit for your business, click the button below for a free consultation:
Not ready to talk? That’s okay! First, learn more about what it’s like to work with CSI by clicking the image below:
