Blogs & Columns
- Posted on: 12/14/2011
- It is well known that employees at bars and restaurants rely heavily on customer tips as a significant portion of compensation as most earn less than the legal minimum wage. It is also well known that all working Americans are burdened by an income tax where the federal government maintains a claim on approximately one-third of all wages. Thus, service sector employees have the dual joy of keeping only two-thirds of their often less than minimum wage while working extra hard to compensate this income with tips that are not guaranteed. Alas, relief may be on its way.Enter Texas Congressman and Republican Presidential Candidate, Ron Paul. Paul recently introduced HR 1139, the Tax Free Tips Act of 2011, which is a bill to amend the Internal Revenue Code of 1986 excluding tips from being subject to both income and employment taxes. Congressman Paul is widely known as a strong advocate of eliminating the IRS and income tax altogether. Since it is impossible to eliminate either overnight, this bill represents a token effort on his part to eliminate some of the burden on taxpayers by addressing service sector taxation on tips.Opponents would argue that tips are income and if everyone must pay their fair share, then so should they. After all, bonuses and commissions are subject to tax, which aren’t technically considered wages. In addition, cash tips are more easily and more often underreported than bonus or commission pay. While all this may be true, there are important distinctions that should be made.First, bonuses and commissions are paid out by employers. Since these payments are part of contractual agreements, employees have certain rights and guarantees to this source of income. On the other hand, tips are never guaranteed sources of income except in some cases where a standard gratuity is automatically added to customer bills. Since tips are not guaranteed or contractual obligations, it would seem that this form of compensation more closely resembles a gift rather than a bonus or commission. Individuals are allowed to receive up to $13,000 per year in gifts that are exempt from taxes. The government allows tax allowances for gifts, so why not for tips where an actual service is being rendered?Second, the IRS addresses the difficulty of accurately accounting income from tips by estimating the taxable gratuity income to that of 8% of sales. So theoretically, an employee could actually owe taxes on more income than they actually receive, since wait staff and bartenders often share their tips with servers, busboys, and bar backs. For example, assume an employee averages 15% gratuity on $1,000 in sales. This would amount to a total of $150 in tips. If half of that amount is shared with co-workers, the employee could actually owe taxes on $80 of income despite only taking home $75.In 2010, the IRS renewed efforts in becoming more aggressive in auditing service sector employees, many of whom are young people trying to earn extra money to pay for their education or as a second job to make ends meet. These taxpayers often do not have the resources to defend against audits.Even government enforcement makes little economic sense. As a practical matter, the associated administrative costs in performing the audit would only offer a marginal net benefit from the recovered collection anyway. Considering the tax breaks, shelters, and loopholes taken by large corporations and wealthy individuals, is the extra hassle on hard working service sector employees often earning less than minimum wage really worth it?There are also the added economic benefits to consider when eliminating this tax on tips. We have a federal government willing to spend hundreds of billions of dollars of taxpayer money in stimulus plans aimed at generating economic activity. So why not free up the extra one-third of the approximate $20-$30 billion in annual service sector tips that would have otherwise been sent to the government in taxes and allow these employees to keep the fruits of their hard-earned labor by spending this money on more goods and services, saving for a home or retirement, or investing in education or a new business?Let’s also not forget that employees are not the only ones bearing the burden from these taxes. Business owners share in this cost through both tax payments and compliance. The reduced cost burden on employers by eliminating the time and money spent on compliance and payments would free up capital that could be allocated toward hiring additional employees.So rather than perceiving this bill as providing a reprieve to a certain segment of our working class, couldn’t we simply consider it a more effective “stimulus plan” to our weak economy?In the meantime, you can follow the progress of this bill at http://www.govtrack.us/congress/bill.xpd?bill=h112-1139. At this point it remains in the hands of the House Committee on Ways and Means awaiting deliberation before being sent to the House floor for a vote. Since most bills never make it past committee, let alone become law, make sure to call or email your representatives to either co-sponsor or support the bill. A website has also been created dedicated to this effort at taxfreetipact.com.And for all you bartenders and wait staff, if Ron Paul comes walking through your bar or restaurant, be sure to offer the man a drink on the house.