November 2004 Edition
Tips & Taxation

by Patricia Nicholson

For most restaurant and bar servers, tips are a major source of income. And where there’s income, there’s income tax.

Anybody who receives tips must report them as income, whether they are tipped directly by customers or "tipped out" from other staff members, says certified general accountant J. Thomas McCallum. That includes bar staff, servers, busboys who receive a percentage of tips from wait staff, maitre d’s — even ministers who perform weddings must declare any tips they receive.

Declaring tips is the responsibility of the employee, not the employer. "It’s entirely a self-assessment system," McCallum says.

The responsibility for keeping an accurate record of tips usually also falls to the employee, because in many cases they do not appear on the T4 slips issued by employers. Tips may be included in box 14 of T4 slips under some circumstances, such as when a business is using a house tip-pooling system in which the staff turns in tips and the restaurant does the accounting and redistribution of the tips, and includes them as part of employees’ pay cheques. In those cases, tips can also be taxed at source.

But for most restaurant staff, tips must be declared as "other income" on line 104 of their annual tax return. And that means the possibility of a big tax bill at the end of April.

Ways to Pay

McCallum says most employees who earn their living from tips are aware that they will have to pay tax on them, but often it’s more difficult to save for taxes than people anticipate.

"There are too many emergencies during the year," McCallum says. "It’s a problem."

Canada Revenue Agency (CRA) charges compound daily interest on any unpaid taxes that are owed. To avoid a crunch at the end of April requires some advance planning.

Employees have the option of paying taxes in quarterly installments like self-employed people do, or they can pay extra taxes on their wages.

"They can just have the employer withhold extra taxes on regular pay," McCallum says.

Employees can ask employers to take an extra $25 or $50 in taxes per week off their pay cheques. It works like an enforced savings program, McCallum says, and come tax time, the bill is largely paid.

Employees can also choose to pay Canada Pension Plan (CPP) contributions on their income from tips, McCallum says. But they must pay both the employer’s and employee’s share of the contribution because it is self-declared income. The advantage of paying the CPP premiums is that the more pensionable earnings a person accrues, the more pension he or she will draw down the line. McCallum says this wouldn’t be an issue for an employee in his or her early 20’s, but might be worth considering for a forty-something employee.

Russian Roulette

How much of an employee’s income from tips needs to be reported? All of it.

"It’s a serious thing to not report your income," McCallum says. You can get away with it for a while, but it’s temporary. McCallum says many employees believe that if they declare a certain percentage of their tips, or if all the servers at a restaurant declare similar amounts as tips, they won’t be caught. Those are old wives’ tales, he says.

"People who don’t declare tips are playing Russian roulette," McCallum says. The government can audit the restaurant and, using records of tips from credit card slips, extrapolate the amount of tips on total sales. "It’s very simple," McCallum says.

The government can also do a net worth assessment on an employee. For instance, if an employee has been declaring an income of $18,000 per year for many years, but has accumulated assets that aren’t consistent with that income, an explanation will be required. "If income can’t account for equity, you’ll be in trouble," McCallum says.

And that trouble can be pretty serious. "There are penalties of up to 50 per cent for failure to report," McCallum says. "There are penalties provided for jail terms, but that just doesn’t happen in this sort of situation." Instead, you will be required to pay tax on the tips you did not declare, as well as interest on that tax, plus a penalty that can be as much as half the amount of the tax.

"It’s very expensive," McCallum says. "It can be more than the tips, because of the interest."

He also notes that government audit methods are difficult to dispute. "They’re very scientific about it," he says. "It’s not always 100 per cent accurate, but what are you going to say? ‘I’m a lousy server and didn’t earn those tips?"

Coming Clean

For people who are haunted by an inaccurate tax return from their past, there is a way to come clean. CRA’s Voluntary Disclosures Program lets people 'fess up' about undeclared income with the possibility of avoiding penalty and prosecution. The disclosure must by voluntary and complete, and a penalty must be applicable to the information (otherwise, there is no need to seek penalty relief under the program). Taxes and interest are still payable under the VDP, but penalties may be partly or entirely waived. Penalty relief is assessed on a case-by-case basis.

"The Voluntary Disclosure Program is very good," McCallum says. "It doesn’t save you the tax, it doesn’t save you the interest, but it does save you the penalty."

There is one catch: you have to come forward before you get into trouble, McCallum says. To be eligible to use the program, you can’t be under investigation.

"So you can’t wait until the heat’s really on," McCallum says. "Then it’s too late." ¨