As much as tips are not expected, they sure are appreciated and welcomed by most massage therapists.
Here’s a typical scenario: On Monday, the total of massage therapist Kathy’s cash tips was $40. On Tuesday, she earned cash tips of $50. For the rest of the week, her cash tips totaled $80. Kathy had a great week with total cash tips of $170.
This $170 was placed in her vacation jar. Kathy didn’t think twice about reporting this money or putting money aside for taxes. She believed since her tips were paid in cash, there would be no trail of this money. How would anyone know, especially the Internal Revenue Service (IRS)?
Kathy is not alone in her thinking, as many of my massage clients think the same way. They believe tips are not—and should not be—considered income, as the price of the service is the income. The tip is the client saying, “I enjoyed your healing hands, and this money is a sign of gratitude.”
I agree tips are a generous way of clients saying thank you. However, the IRS doesn’t feel the same way. In the eyes of the IRS, all tips, whether cash or non-cash, are considered income, which is taxable.
4 Questions Answered
While performing monthly and quarterly accounting tasks, I ask massage clients “Did you receive any cash tips”? After they answer the question, I am often asked the following:
1. Will taxes be taken out of my cash tip income?
Yes, the IRS requires the employer (or self-employed individual) to withhold taxes from tip income, the same way taxes are withheld from your regular wages.
2. I am self-employed, should I be putting money aside for the cash tips?
Yes, I advise you to put aside 25 to 30 percent of the tips, as you are responsible for paying and reporting all tip income.
3. Whose responsibility is it to keep track of cash tips?
The responsibility of reporting tips is yours, as an employee or a self-employed individual. The following are things that you should do to prevent any potential issues with the IRS.
• Keep a record of all your tips
• Add up your tips and report them monthly
• During tax time report your tips again
4. Do I need to report all my cash tax income?
No, the IRS guidelines states tips (cash and non-cash) of $20 or less during the month are not taxable during that month or pay period.
We live in a world of credit cards, and so many clients do not pay tips with cash. Nevertheless, the massage industry, like similar industries, that receive tips are always on the IRS radar to report tip income.
From the IRS’s perspective if/when tip income is not claimed it is tantamount to fraud. This type of fraud can and will lead to a tax audit, fines and penalties. Also, the IRS will use their calculation of what they believe your tip income should be.
Being honest is the best policy, as the IRS calculation may not be correct. Why pay taxes on tip income that you didn’t receive? Why put your business through unnecessary stress? I can honestly say it is not worth the headache.
In the past when most tips were cash tips, it may have been easier to hide these from the IRS, as ill-advised as this is.
However, in our society where many clients pay for massage services with credit cards, tips are recorded as such on these credit card transactions. Take a look at your business credit card portal; it asks the client if they would like to leave a tip. If the client selects yes, the amount is calculated and recorded as tips. The merchant service sends the total tips calculated to the IRS at the end of the month under the business EIN number.
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Keys Steps to Take
Keep a record of tips. Get into the habit of making a record of your tip income. Recording tip income is important especially if you have to share or pool your tips together. This may not apply to a single owner run business but getting into the habit of good record keeping is never a bad idea. There is an IRS tax form (Form 4070A) that can be used to keep a tally of your tips.
Report tips monthly. The IRS mandates that any tips that total more than $20 need to be reported to your employer. A similar form to the one above (Form 4070) can be used for this. These need to be reported on the 10th of the month, each month. One of the reasons for this is to allow your employer to calculate the payroll taxes that need to be withheld during the pay period.
Report tips again during tax time. Your W-2 should reflect your income from both wages and tips. When you file, you have another opportunity to report all your tips, even from months when the total was less than the above stated $20.
You can also use the IRS form 4137 to claim unreported tip income as well as non-cash tips that you received (Yes, the IRS still considers these non-cash tips income).
The IRS will sometimes assume that a certain industry-specific percentage of sales is from tips. If you deviate to low based on the industry standard, it may be a red flag. For instance, if the massage industry generates tips equaling 8 percent of sales and you report only 1 to 2 percent in your business, this may be a red flag.
About the Author:
Lozelle Mathai, MBA, CFEI, is the owner of The Body of Accounting, which specializes in cloud based accounting, bookkeeping, accounting education and financial management services for health and wellness professionals. She is regular contributor to MASSAGE Magazine, and her articles include “Your Financial Techniques Are as Important as Your Touch.”