The Ins and Outs of Accepting Gratuities
Tips are a good thing, right? After all, they show client appreciation for a tech’s hard work and can significantly boost one’s income. But tipping diverts to the dark side when techs and salon owners aren’t properly informed on tax and reporting requirements.
Truth or Consequence
Confusion about tipping runs rampant in any industry where gratuities rule, and the beauty business is no exception. “Unfortunately, we learn to pocket tips in beauty school,” notes Jaime Schrabeck, PhD, salon owner and licensed manicurist at Precision Nails in Carmel, California. “Schools could be doing much more to teach about tax compliance; even many salon owners don’t know the legalities.”
The bottom line: Tips are considered taxable income, subject to Social Security and Medicare taxes. “Unless the tips total less than $20 for the entire calendar month, they must be reported to the employer,” explains management consultant Tina Alberino of This Ugly Beauty Business in Tampa, Florida. “In addition, employees are required to maintain a daily tip record and report all tips—including those under $20 they weren’t required to report to their employer—on their tax returns.” (The IRS’s Publication 1233 facilitates tip tracking and reporting; find it at irs.gov/pub/irs-pdf/p1244.pdf.)
Not properly reporting tips triggers several consequences, Alberino adds: Those who underreport income can be denied loans or credit, and a potential lender may file a Suspicious Activity Report, which alerts the Internal Revenue Service (IRS) about fraudulent activities. You may also be subject to an audit. “The IRS considers underreporting a form of tax evasion, and those who are found guilty face a penalty equal to 50 percent of the Social Security and Medicare taxes they owe on the unreported tips—that’s in addition to the taxes you owe,” says Alberino. “You could also be subjected to wage garnishments, bank and asset levies and even jail time.”
Meanwhile, employers are required to withhold and match employment taxes on all employee wages, including tips. Failure to do so compromises employees’ benefits and can incur serious criminal and civil penalties. Schrabeck trains her employees to record any tips (cash or credit) with each transaction. At the end of every workday, employees receive their tips in cash, without deductions. Then, when completing payroll every two weeks, Schrabeck reports the tip totals so taxes can be withheld.
Many techs and salon owners are now going “tipless” to avoid the gratuities quagmire altogether. Both Schrabeck and Alberino agree that a tipless salon offers a range of benefits: Customers don’t determine a tech’s wages (creating steadier incomes), while employees and employers needn’t worry about accurately reporting tips, as the expense is built into the service price. Alberino has found that no-tipping policies (in her own and her clients’ salons) have been extremely well- received by customers.
“Additionally, tipless business employers are able to strictly manage their employment tax burden,” says Alberino. “Tips are unpredictable income that employers have no control over and are expected to match taxes on. Those taxes (combined with any applicable credit card processing fees) can add up fast.” For example, $200 in tips results in a $15.30 federal tax liability for the salon (6.2 percent for Social Security and 1.45 percent for Medicare). If 12 employees receive $100 in holiday tips from each loyal client, the employer’s tax burden becomes substantial.
Considering going tipless? Alberino advises taking the appropriate steps: First, evaluate your pricing and service protocols. To offset the lack of tip income, increase employees’ wages (or, if you’re self-employed, increase your desired salary). Once you’ve adjusted wages and determined what the service must cost, increase the cost to meet the client’s perceived value. “If the cost far exceeds what clients are willing to pay, you’ll need to correct some serious imbalances—in service execution time, product cost, and/ or overhead expenses—until the service results in a profit.”
Software programs like Tippy are designed to make the tipping process easier, as well as many business- streamlining software systems. Still, policies can get confusing, warns Sean Persha, vice president of sales and business development at DaySmart in Ann Arbor, Michigan. “The correct process of tracking and attributing tips is critical in any service business,” he says. “But what happens if a client sees multiple providers during a visit, then tips on the total on her way out?”
In other words, does the tip get split as a percentage of the invoice? Does a 10 percent tip mean every provider gets 10 percent of the service cost as a gratuity? Do the three providers split the tip evenly? “There’s more complexity when service levels or tiered compensation plans dictate when certain providers get a larger share because of seniority or expertise, or because their service took longer,” says Persha. “A very attentive front desk person can account for complicated revenue splits, but salon management software that tracks services and commission details helps avoid conflicts.”
Software can assist via reports that show each service provider’s compensation, but Persha stresses that it’s most important for owners to communicate the process to the staff, envisioning every possibility and discussing it as a group. “Pooling tips creates a perverse incentive for low performers (they’re rewarded for someone else’s work), but complex revenue splits can lead to confusion or a larger reporting burden,” he explains. “Have a policy
and stick to it. How you handle—and communicate—these payments are critical to keeping staff happy while limiting the mathematical gymnastics.”
The Latest Legislation
Last September, the Professional Beauty Association (PBA) asked the beauty industry to support H.R. 6736, commonly known as the Federal Insurance Contribution Act (FICA) Tax Tip Fairness legislation. This would “extend the FICA 45(b) tip tax credit to salon and small beauty businesses … and would improve tip reporting, promote tax fairness and help small businesses,” the PBA reports. “Employers should not be responsible for paying FICA taxes on tip income not paid by them to their employees.” For more information and to take action, visit probeauty.org/fica.
–by Tracy Morin
This story first appeared in the April issue of Nailpro magazine. To receive the magazine, click here to subscribe.