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Subject:  Re: Out of Curiosity: On Tipping Date:  3/30/2008  12:08 PM
Author:  TMFPMarti Number:  99889 of 127745

I was wondering if somebody more knowledgeable might be able to point me towards the relevant IRS documents regarding taxation on tips to help me understand the following query.

Publication 531

My question is this: What is the rational for collecting income tax on tipping?

It's compensation for services rendered.

If a waitress serves me at a restaurant, she is considered an employee of the restaurant rather than an independent contractor, correct?

Usually, although there's the rare exception. I started my IRS career in Chicago, and during training when we were discussing the employer/employee relationship the case of The Berghoff, a famous Chicago restaurant, came up. (It was also less than a block from the office and Monday's lunch special was wonderful turkey croquettes with creamed spinach, so field investigation was called for.) I digress.

This particular restaurant used a strange system I've never seen anywhere else. The waiter (no waitresses until the EEOC got after them) took your order then bought the food from the kitchen with special scrip. You settled with the waiter, never doing financial business with anyone else connected with the restaurant. IRS had taken them to court and lost. But almost always, yes, they're employees.

Thus, wages gained through the employer should clearly be subject to income tax...but what about transfer of money directly from me to her? If I decide to give the waitress, directly and purely out of goodwill, an extra $10 above and beyond 15%, why should that be taxed rather than considered a gift subject to the $12,000 non-taxable gift limit? What if (creepiness factor aside), I wait outside the restaurant for the waitress to finish her shift and then give her $10. Is this considered a tip and subject to taxation?

I wouldn't recommend the latter. You might be mistaken for Eliot Spitzer. Yes, it's all compensation for services rendered.

As you'll note during your fascinating trip through Pub 531, there's a curious interaction between the employer and the employee regarding tips. More insight to the employer's side comes from that best-seller Publication 15, Employer's Tax Guide, sometimes referred to by its pseudonym, Circular E.

For your graduate studies there's always "allocated tips," a statutory stab at increasing compliance in an area of notorious underreporting. (In my salad days I knew a lot of bartenders, and whenever they'd get close to the topic of tips I'd pipe up with something along the line of "Ya know, since I work at the IRS I hear a lot about people who underreport tips, and am I ever glad that ya'll report every penny since I'm required by law to turn in anyone I suspect of cheating.") I was present at the creation of the procedures for allocated tips, and boy was that fun.

A second follow-up question also is raised by this post: I'm asking for references to IRS Tax Documents to read for fun and out of intellectual curiosity. What is wrong with me? :-)

Face it, you're hooked. Check out Tax Wonks Anonymous. Also see the thread I'm about to start in an effort not to hijack yours.

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