Watch Out for Tip Creep in Your Business

I’m sure you’ve noticed the rising pressure to tip in recent years. You go to pay for your drip coffee, the barista flips over the kiosk, and you’re confronted with the request to tip. I had lunch at a new restaurant and the owner and I struck up a conversation regarding her employee tips. Of course, I recommended that they speak to their own licensed professional but I did point out a few tips.

And also wondering… Am I obligated to tip you to pour a cup of drip?

Of course, no one wants to be rude, so we often choose an amount — from suggestions ranging from 18–30% — while being bothered that we are asked for tips everywhere nowadays, it seems.

Tip creep, or “tipflation” — the spread of gratuity from the traditional restaurant to more industries such as drivers, baristas, ice cream shops, etc. — started as a token of generous goodwill during the pandemic. People wanted to thank delivery services and others who helped us all feel normalcy.

However, the expectation to tip hasn’t returned to normal after 2020… and now consumers are beginning to resent tipping, especially in light of inflation.

You understand the frustrations that come with this as a consumer. But you might not have considered the effects of tip creep if you are a business owner and how it could get you in trouble with the IRS.

Sometimes, businesses don’t require employees to report all tips (maybe just a percentage, or they don’t report at all). This is an especially easy trap to fall into if you have employees (ex: food delivery drivers) who can easily take physical cash tips and just never report them.

So the problem with the IRS comes because you now have employees making money that never gets documented anywhere. (This goes without saying, but — that’s illegal.)

And this is why I’m seeing more and more employers being investigated for payroll fraud due to tip reporting violations.

So this is my warning to you today: Under the Internal Revenue Code, all employees must report all income (including cash) or face penalties. Employers who knowingly allow employees to do this also face penalties, so it’s wise to educate yourself on the topic.

Allow me to do just that…

Not that “minimal”

All tips — whether cash or non-cash — are considered income and subject to Federal income taxes. According to the IRS, “cash” tips include those received from customers, charged tips (like debit or credit charges) distributed to them by the employer, and tips received from coworkers under any sort of tip-sharing agreement.

Under the de minimus rule (Latin for “pertaining to minimal things”), the only scenario in which an employee doesn’t have to specifically report cash tips is if they total up to less than 20 bucks for the whole month. Now as someone who had siblings that worked tipped jobs while in college I know even back in the 80’s they received more than $20 a night!

If an employer knows about a violation of this rule and gives them their paycheck anyway, they have violated the law by paying them without adequately accounting for their reported income. The IRS even has a form for that ( of course they do). It is Form 4070 and available for free on the IRS website.

The danger

So if you’re an employer, you want to watch out for these things related to tip creep:

Cash tips that an employee does not report on a tax return are also not included in their paycheck. This means you could be unaware someone is using unreported income (like tips) to, say, help them pay their apartment’s rent each month.
Say one day your company gets audited by the IRS because one of your competitors got caught up in an audit too, and now the IRS is looking at other companies in your industry for additional revenue collection purposes. One of the first orders of business will be pulling your payroll records and having them reviewed by the IRS auditor assigned to your case. If they find that one of your people has been regularly receiving unreported cash payments from customers, that raises a very red flag. The results: They’ll conduct a deeper audit on your whole business because of something an employee did behind your back.

The audits sometimes appear on the state side first especially the unemployment reporting department. Then it creeps to state revenue and finally the IRS through data-mining gets their hands in the pie. You are now having a bigger problem than just having employees reporting their tips.

You technically broke the law by allowing this to happen under your watch as an employer, and there are penalties for that.

The fix

There are some measures business owners can take to ensure compliance within your company and avoid any payroll fraud. Consider implementing any of these that you don’t already have set in place:

Ensure your people understand how important it is to accurately account for ALL income, including cash payments made by customers (even the things that it seems like no one pays attention to). Then actually teach them how to accurately record those payments or tips in the system.
Clearly define the difference between a tip and a fee — and how to document the difference on their paychecks.
Have all employees who handle customer payments (servers, sales reps, etc.) put all such payments into a special bank account that can’t be accessed without approval from management first. This prevents improperly pocketing any money without accounting for it.
Conduct regular audits of tip records, and resolve anything that’s not adding up.
Finally, this is perhaps the most important one: Create a culture of honesty and compliance in all areas of your company, not just this one. Believe me, tracking tips won’t go over well if honesty, valuing each other’s work, and respect for necessary procedures aren’t staple values in the company.

If you haven’t given much thought to tip creep before, I recommend employing these strategies ASAP and even conducting an internal company audit to make sure nothing is going on that shouldn’t be. We would love to walk through the details with you, if you like. Just claim your spot on the calendar, and we can fine-tune your procedures so your company is in tip-top shape.