The FairTax and tips/gratuities

Nate and others contributing to this thread:

SS benefits are not directly based on the taxes one pays in, they are determined by the individuals wages. This reporting is maintained under the FairTax.

The section of the law you included defines wages to be reported to the Social Security Administration for the purpose of determining social security benefits. The FairTax definition of wages is the same as that used currently to determine SS benefits.

As you know wait staff have some of the lowest wages around and to not include the tips they get in what is reported to the Social Security Administration would leave them eligible for much lower benefits when the time to retire comes.

There is no language in HR25 that mentions "tips" on the context of what is taxable; however, tips are clearly part of the gross payments for a taxable service, as all services are taxable.

The FairTax taxes all personal consumption except for charitable contributions, education tuition (investment in human capital, and business purchases for a bona fide business purpose, and exports).

HR25 is very specific, but it still delegates certain things to the Secretary of the Treasury: specifying forms, for example. Every state has a sales tax statute and then sales tax regulations. The FairTax will be no different. The particulars of every business cannot be taken into account in a piece of general legislation.

The treatment of tips is one of these areas. For certain, I can say that if the restaurant has a policy of mandatory tips (say 20%) on parties greater than 4 that is automatically added on to the bill, it will be included in the amount subject to the sales tax. An internet search revealed that New York City and Los Angeles apply their sales taxes to tips in this fashion.

There will most certainly be some regulations on how the FairTax on tips will be handled just as there are some regulations on how tips are reported as income today.

However, personal consumption is much, much simpler to define than income. The only definition of income by the IRS is "income derived from whatever source", which the IRS keeps adding to every year.

Yes there are tips that go unreported as income and untaxed under the current system. Yes there will be tips that go unreported as consumption and untaxed. Tips are payment for the consumption of waitress services, nevertheless.

Finally, it is a matter of the restaurant goer to pay tax on the full value of his/her personal consumption. Not a matter of the waitress's income.

Karen Walby, Ph.D.
Tax Economist