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GIANT TIPS AND TAXES (NOW WITH UPDATES!)

September 18, 2006

See update below.

Professor Maule ponders the how to draw the line between a gift and compensation when somebody leaves a colossal tip:

What facts relevant to the tax issue are known? The customer has always tipped well, according to the bartender, usually leaving $15 on a $30 tab. Two weeks ago, the customer left the bartender a $100 tip on a tab of under $50. Then came the $10,000 tip. The customer put the tip on a credit card. Rather than following his usual practice of turning the credit card receipt upside-down after signing it, he kept it facing up and said to the bartender, I want you to know this is not a joke." During an interview, the bartender said, "I hate to say it, but I really don't know him. You become friends with your customers ... I think he just appreciated the fact that I took the time to talk with him."

Tips are taxable. Does this somehow cross the line to a gift, which isn't subject to income tax? My short answer: no, it's income. Dr. Maule, in a more nuanced way, gets to the same place:

Assuming the customer's intention matters, does any of this disclose customer's intention? Yes and no. He did not say, "Here is a gift." He put the $10,000 on the credit card receipt, presumably on the line that is left there for tips. Where else would he have added it in? He is a generous tipper. Fifty percent is generous. So, too, are the $100 and $10,000 tips. It looks like a tip, it walks like a tip, it talks like a tip, so is it or any part of it an excludable gift? The burden would be on the bartender to prove it is a gift. The restaurant withheld federal income tax. I predict the $10,000 will be reported on the W-2 it provides to the bartender next January. That creates a very challenging burden. Can the bartender show they were friends after saying she doesn't really know him? Was it her birthday? Did they interact outside of the restaurant? Was there any communication outside of her employment activities? There are no facts so indicating. Looking to the transferor's intent poses problems, because the taxpayer may not ever have the opportunity to ascertain the intent or to present it in some way as evidence during an audit or in litigation. It wasn't a joke, but that doesn't mean it was a gift. Or was not a gift. When we think of gifts we think of birthdays, anniversaries, get well wishes, and similar transactions between people who have something more than a business relationship. I don't think the $10,000 was a gift. There's no evidence that it was, and what evidence there is suggests that it is not.

I'm much more thoughtful than Mr. Show-off Tipper. No bartender ever has to worry about me causing her tax problems!

UPDATE:

From the comments:

I believe the 'real' tax controversy in this situation involves JS Enterprises, owner of the Applebee's in Hutchinson, Kansas, where Ms. Kiernow tends bar. There is no question that tip income - while often paid directly to the employee from a customer - is, in fact, imputed wages. Since January 1988, employee tip income has been treated as employer-provided wages for purposes of the Federal Insurance Contributions Act (FICA), as if those tips were wages paid directly to the employee from the employer.

In other words, one-half of the FICA tax burden on the $10,000 tip is borne by the bartender, while the other one-half of the tax (7.65%, or $765 in this instance) is a "contribution" by the employer - depending on whether: a) Ms. Kiernow earns more than the OASDI ceiling of $94,200 this year; and b) JS Enterprises can use the IRC sec. 45B INCOME tax credit for employers operating food and beverage establishments.

Bottom line: the other blogs have taken up the cry of "stealth tax" on behalf of bartender Kiernow. Who will take up the cudgel for her employer, if not you?

There are other blogs?

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