PUBLISHER'S PAGE: Why Are Operators Subject To Paying Taxes on Tips?

Posted on January 4, 2011 by LCT Staff - Also by this author

JANUARY 2011 LCT: Operators should be able to report a tip as an “allocation” which would absolve him or her from paying out employee taxes on that tip money.

Did you know that the higher the chauffeur tip is on your client bill, the more money it costs you as the employer? Well it does.

Since you have to pay 18 cents worth of employee taxes on every dollar, then an 18% tip is costing you more than a 10% tip.

Gratuities by law cannot be withheld in whole or in part by the business. The entire “tip” must be PASSED THROUGH to your chauffeurs. I understand that the trend to tack on the gratuity emerged in the late 1980s when more and more work moved away from cash to client-direct billing programs.

Corporations moved away from allowing business travelers to handle tips via cash to have better control. This is precisely the time in our industry where we failed to realize that in doing this, the tip erroneously became part of the chauffeur’s wage. In reality, a pass-through gratuity tax is solely the responsibility of the recipient, not the establishment.

Don’t get me wrong. I’m not against chauffeurs earning tips. What I object to is the IRS coming to the employer to pay taxes on those tips on top of taxes paid on their hourly wages. The tip should be kept separate.

Operators should be able to report a tip as an “allocation” which would absolve him or her from paying out employee taxes on that tip money. From a tax standpoint, there is zero financial benefit to the employer on tips since all that money goes directly to the employee. BUT the employer is compelled by law to pay taxes on it. How is this fair?

I think we, as an industry, should try to get the IRS to view tips not as wages but as “gifts” which can be reported by the employer as an “allocation” at the end of the year. If we accomplished this, the chauffeur would be responsible for paying his own taxes and the employer would no longer be required to pay any Social Security, unemployment, or payroll taxes, for that matter.

Yes, that would mean the chauffeurs would pay more taxes on those gratuities than before, but I believe that’s justified. We should put the burden where the burden belongs. And the burden belongs to the person receiving the gift — the tip (by law a gift is taxable income). The only reason the weight of this gets foisted onto the employer is because it’s easier for the IRS to monitor the physical business than it is to watch over a moving target such as an employee is considered to be.

Here’s the challenge that we face with the IRS when arguing about this issue: When an owner builds the tip into the overall ride via billings, then the IRS will likely rule that this is a mandatory tip and constitutes a wage. Our comeback to that is this: Although most of our clients prefer the tip to be included on the bill, it’s important to note that is still a separate line item on the bill.

Also, tips aren’t really mandatory; more correctly stated they are assumed or automatically applied per the client’s request. Tips can definitely be disputed and removed from the bill if the client is unhappy with the service performed by that chauffeur. The client always has the option of having the tip included on the final bill for convenience sake or paying chauffeurs with cash. Corporate accounts typically opt for direct billing because it’s more agreeable for them.

For the record, the hospitality industry argued this case and was awarded a huge concession. In the food and beverage business, owners must declare a minimum 8% of their employee tips to the IRS. But they are allowed to declare this as an “allocation” — key word for NOT having to pay any FICA or unemployment or any other employee tax for that matter. So why can’t we do the same? Think about it. Owners could put that 18% tax they pay out (with no direct benefit) straight to the net profit of their company.

This might be well worth the National Limousine Association’s time to pursue. If they succeeded in creating a special circumstance for our industry on the federal level by negotiating a deal with the IRS, then chances are very high that states would comply as well.

Sara Eastwood-McLean

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