Taxing Definitions

Definition — The tipping point

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Image source: Sam Truong Dan on Unsplash

 

To tax those tips or not? Tips are not defined in the tax code or regulations so the determination of whether a payment is a tip depends on four factors. The absence of any one factor creates doubt as to whether the payments are tips.

In Office of Chief Counsel memorandum 2018-16010, the question was whether cash amounts distributed to individuals from “tip boxes” were tips.

Here are the facts.

The taxpayer engages individuals to perform services at the taxpayer’s request and on the taxpayer’s premises. The taxpayer treats the individuals as volunteers and does not directly pay the individuals any form of compensation or benefits for their services.

The individuals receive cash payments from amounts contributed by customers. The cash amounts are deposited by customers in “tip boxes.” Customers are not required to make cash contributions and have discretion on how much cash to contribute (including none).

The amount of cash in the “tip boxes” is distributed at the end of each shift. Individuals who performed services during a shift determine how to allocate the tip box amount between all of the individuals who performed services during that shift.

The taxpayer does not have a system in place for individuals to provide written statements reporting the cash amounts received and has no knowledge of the specific amount of cash received by each individual. The taxpayer does not issue Forms W-2, Wage and Tax Statement, to the individuals and has not included any wages or taxes in connection with their services on federal payroll tax returns.

The taxpayer has the right to direct and control the individuals as they perform services.

Per Revenue Ruling 2012-18, the factors used to determine if payments constitute tips are:

1) The payment must be made free from compulsion;

2) The customer must have the unrestricted right to determine the amount;

3) The payment should not be the subject of negotiation or dictated by employer policy; and

4) Generally, the customer has the right to determine who receives the payment.

 

Note that this situation involved a tip jar and the determining factor is number four.

 

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Note: Taxing Lessons provides a summarized version of sometimes lengthy internal revenue service decisions. The full document may include facts and issues not presented here. Please use the link provided in the post to read the entire document.

This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.

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Under the facts presented, the four factors set forth in Revenue Ruling 2012-18 have been satisfied. The fact that the cash contributions are collected by the individuals who work during the shift and pooled for purposes of distribution among them satisfies the fourth factor. The customers generally have the right to determine who receives the payment when the tipped amounts are pooled and the individuals working each shift distribute the cash among themselves.

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