Tips on reporting tips at income tax time

"Heads-up to employees in the service industry: Canada Revenue Agency (CRA) is paying close attention on the reporting of tips."

Heads-up to employees in the service industry:  Canada Revenue Agency (CRA) is paying close attention on the reporting of tips.

In the summer of 2012, news broke that CRA had conducted a two year pilot project auditing 145 service workers in 4 businesses and discovered 1.7 million dollars of unreported tips.

In essence, the servers had only reported half their actual income and on average wound up owing about$1,550 each in unpaid tax.

In fact, CRA tax experts estimate that tips in some segments of the service industry not only double one’s income but may actually quadruple it.

At the same time, it appears the rule of thumb is for service workers to report as little as 10% of their tips … but as governments scramble to find revenue you can bet this windfall of tax revenue from 145 services workers will not be treated as a one-off audit.

“How would CRA ever figure out if little ole’ me reports my tips incorrectly?”

Well, in addition to the fact that audit attention by CRA on tips will continue, one should realize that CRA has access to all tax returns and cross-comparisons are as easy as the click of a mouse.  CRA can easily ascertain the average tips and the range of tips reported, drilled right down to the co-workers at place of work.  By the way, fitting within these parameters is likely a good thing.

What to do, besides the obvious of reporting all tips?

Keep a logbook that lists the value of tips received and on what date, and whenever there is something unusual, note why tips were up or down that day.  Although not bullet proof from CRA scrutiny, CRA does love this type of tracking.

What about the tax liability created by tips?

Because tips are usually reported annually as “other income” with no portion of those tips withheld and remitted to CRA by your employer on your behalf during the year, a service worker could have a large tax liability at the time of filing.

One solution is to ask the employer to withhold more of your regular wages as taxes every pay period.  The other is to set-up instalment payments with CRA that are remitted directly to CRA quarterly.  Interestingly, you may not have this as an option because CRA may demand quarterly installments once your level of “other income” is established.

On a positive note, “other income” qualifies as earned income, and the higher one’s earned income, the higher one’s Canada Pension Plan cheques upon retirement … but of course this means CPP premiums have to be paid on the tips.  Don’t worry, your tax preparer will, or software should, calculate the premium due at time of filing automatically for you.

Finally, service workers please don’t feel picked on by CRA.  This CRA pilot project also included audits in the trucking industry, web-based sales, retail cash register manipulation and even house flipping.

Ron Clarke has his MBA and is a business owner in Trail, providing accounting and tax services.  Email him or see all previous columns at ron.clarke@JBSbiz.ca