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Tips and Your Taxes: What Every Tipped Employee Needs to Know

This is for you if you accept tips as part of your work or career, whatever it is you do for a living.

Tips are a way to express gratitude for a job well done, whether you work for someone else or for yourself. Tips are also often a real income booster for those who wait tables, cut hair, or provide someone with a safe ride home. Increasingly, many small businesses, and even content creators, are following a trend of accepting tips for their work too, even online.

But what many might not be aware of are the tax implications associated with receiving tips. All tips, whether traditional cash in hand or digital donations sent to you because you are someone’s favourite online creator, are considered taxable income. This applies not only to wait staff, hair stylists, and drivers, but also to small business owners and even yes, content creators who receive virtual “tips” from their audience.

Do I Really Have to Pay Tax on All My Tips?

According to the CRA, you must declare all tips and gratuities on your income tax and benefit return since they are all taxable compensation for the work you complete. And tips, in their eyes, can be broken down into two different categories:

Controlled Tips

Tips that are collected, managed, and paid to employees by their employers are known as controlled tips. Controlled tips are regarded by the Canada Revenue Agency (CRA) as business income for the employer. Controlled gratuities are therefore a kind of compensation from which employers are required to deduct CPP and EI contributions.

As an illustration, imagine that you are a server at a restaurant where the owner divides the tips equally among the entire workforce. These are controlled tips.

Other examples of controlled tips include when employers:

  • Add mandatory service charges or a percentage to a client’s invoice to cover tips
  • Distribute tips to their employees using a tip-sharing formula
  • Include tips in their business income and later pay them to their employees

Uncontrolled or Direct Tips

Direct tips, which clients give to employees directly, are untaxed income. Employers are not subject to CPP or EI payroll deductions because they have no control over this sum. By completing Form CPT20, an employee can decide whether to contribute to the CPP. Although direct tips won’t appear on your T4 slip, you must still record them as income on Line 10400 of your tax return.

It’s possible, and in fact, increasingly common, for employees to receive both controlled and direct tips. In this case, only the controlled tips would be part of the employee’s pensionable or insurable earnings, or both.

How Should I Report My Tips at Tax Time?

How you report tips can vary depending on how you get them, whether from a customer or your employer. Instead of an estimate or a percentage of earnings stated on a T4 slip, the CRA expects the income amounts you report to be a true number reflecting tips collected in a tax year.

Here’s a breakdown of how to report the different tips you receive:

Controlled tips

Your T4 slips will have your employment income in Box 14, which may include controlled tips. Enter the total amount from Box 14 on Line 10100 of your return.

Direct tips

For income that’s not reported on a T4 slip, enter the total amount of tips you received on Line 10400 in your tax return.

Declared tips

Report your tips at the end of each pay period by filling out form TP-1014.4-V.

Why Should You Report Direct Tips at Tax Time?

Is it tempting not to report some direct tips, especially if they are cash tips? Obviously, the answer is yes. However, beyond complying with the tax laws and protecting yourself from tax penalties and audits, reporting your direct tips means that you’ll have a higher total income, which does offer you some financial benefits in the long run, including the following:

Larger RRSP Contributions

Depending on the income you reported from the prior year, there is a restriction on how much you can contribute to your Registered Retirement Savings Plan (RRSP) each year. Your contribution room increases more quickly as your income increases.

Growing your contribution room early can position you for a better financial future, even if you aren’t close to retirement and don’t plan to save money this year.

Speaking of retirement, while no CPP and EI contributions are deducted from direct tips, you can choose to make voluntary CPP contributions on tip income using Form CPT20, which enables you to retire with a bigger pension.

An Improved Credit Profile

Getting a mortgage to buy a home in Canada is something that most people aspire to do at some point, and to do that, you will need a credit profile that is as strong as possible. A credit profile is NOT a credit score (that is just a part of it) and your income is taken into account.

Having a higher income will improve your credit profile, which can, in turn, help you qualify for a larger loan or mortgage, which can be a big help, especially in today’s Ontario real estate market!

Avoid Hassles With the CRA

The CRA knows that certain people in certain professions get direct tips, whether they choose to report them or not. This does mean that they might be targeted for an audit. Audits are stressful, to say the least, and can get very complicated if you are a direct-tipped employee who did not declare said tips.

You will be responsible for paying what you owe, plus interest and possible penalties, if the CRA reevaluates your return and finds that you left out a sizable amount of your income. It’s a good idea to keep track of your tips and record them accurately on your tax return to prevent the hassle of having to update an old income tax return and paying fines.

In the end, we know you put a lot of effort into earning your tips, and while it may seem tedious, and even unfair, to have to report them at tax time, there are long-term benefits to raising your overall income. There are also tax credits that may be able to help you keep more than you earn.

If tips are a part of your working life, you may want to consider working with a professional when filing your taxes this year. Not only will we help you ensure that your tip income is reported correctly, but we can also help ensure that you get all the tax credits you are entitled too while also helping you come up with a financial plan to maximize your income this coming year and in the future. As it’s tax time right now, contact us today to get started.