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How tips are taxed
Whether you are a waiter or a taxi driver, if you get tips (even cash tips), you cannot just put them in your pocket or bank account and be done with it! Here we explain how tips are taxed and tell you how to stay on the right side of HMRC.
Tips are an important source of income for many low-paid workers, particularly in the hospitality sector but also in other sectors such as hairdressing and taxi driving.
If you get tips, you need declare them properly for the purposes of tax and, where applicable, tax credits and universal credit. This applies whether you are an employee or self-employed, and whether you get them in cash or in another way. Just because tips don’t count as income for National Minimum Wage purposes, that doesn’t mean they don’t count as income for other purposes!
What are the rules on tips for employees?
Some customers leave tips in the form of a service charge or by adding it on to a debit or credit card payment. When a customer pays a tip directly to the employer in this way, there is currently no legal requirement for employers to pass on the amount on to their employees (either fully or in part).
Where some or all of the amounts are passed on by the employer, then the employer must operate Pay As You Earn (PAYE). This means that your tax and National Insurance (NIC) liabilities on the tips should be deducted before you receive them. This also means that you should not have to do anything else to notify HMRC or DWP about your tips for tax, tax credits or universal credit purposes.
A similar situation occurs where tips are paid via something called a ‘tronc’. A tronc is where tips are pooled and where someone other than the employer (a head waiter or waitress for example) controls and distributes them. Tips paid through a tronc should be taxed before you receive them. But if the tronc is set up correctly, tips can be paid NIC-free through the scheme. This saves you money.
You can find HMRC’s booklet E24 on GOV.UK. This contains guidance on tips, service charges and gratuities and explains how troncs should be operated. Please note that although this guidance is aimed at employers, employees may find it useful too.
You can also find more information about tips at work on GOV.UK, including a link to a voluntary Code of Best Practice on tips that suggests how employers should handle them.
If an employee gets cash tips directly from a customer without the employer being involved, the tips belong to the employee. This includes any change left on the table by a customer for the employee, any cash handed to the employee and any money left in a tip box or dish by the till to be informally shared out (in which case it belongs to the employees as a group).
Although tips do not count as ‘income’ towards the National Minimum Wage – meaning that you should receive the minimum wage with any tips on top – cash tips should not be thought of as a ‘gift’. Rather, they are classed as employment income which means they are taxable (but not NICable) on you. While they are taxable, there will not be any tax deducted from them. This means you are responsible for telling HMRC about these tips, however this is possibly often overlooked.
As such, and to stay on the right side of HMRC, we suggest:
Keep a good record of your tips
You will have to show cash tips received on your Self Assessment tax return (if you fill one in). If, as in many cases, you do not have to fill in a tax return because all your income is taxed under PAYE, you should tell HMRC about your cash tips. HMRC will usually adjust your tax code to collect the tax due. Otherwise, they may send you a bill at the end of the tax year or ask you to fill in a tax return.
You can tell HMRC to adjust your tax code via your Personal Tax Account or by phoning the HMRC Income Tax Helpline on 0300 200 3300 (textphone 0300 200 3319). Have your National Insurance number with you when you phone. It is a good idea to make a note of the date and time of your call, as well as the name of the adviser that you speak to and what is said.
To adjust your tax code, HMRC will need to know how much you received in cash tips. This means that you have to keep a good record of what you have received. If you do not do this, HMRC may estimate your tips. This might be a rough calculation based on the sales of the restaurant and the number of employees. This could lead to an overestimation of your cash tips and you paying more tax than you need to.
Don’t forget about tax credits and universal credit
The meaning of employment income for tax credits and universal credit broadly follows employment income for tax purposes. As such, any tips you receive may be counted as employment income for benefits purposes.
HMRC use the employment income information provided on an employer’s Real Time Information (RTI) payroll reporting for universal credit and as part of the tax credits renewals process. Tips that are paid through PAYE (including under a tronc) will be included on RTI payroll reporting and will be automatically picked up for universal credits and tax credit renewals.
RTI payroll reporting will not show cash tips, so unless you declare them as employment income to HMRC or DWP yourself, your benefits award might be wrong. This could result in your receiving too much money in benefits and possibly a penalty.
Keep an eye on your tax code
Once HMRC have ‘coded in’ an amount in respect of your tips, this is not the end of the story. Make sure you check your PAYE coding notice regularly to check if the amount is still accurate. If you do not do this, and the amount of tips you receive goes down, you will end up paying too much tax. If the amount of tips you receive goes up but the amount in your code stays the same, you could end up owing HMRC money.
Can I use the trading allowance to cover my tips?
Tips are taxable as employment income because even though they are given to you by a customer, they relate to an employment.
The trading allowance allows you to get a small amount of ‘miscellaneous’ or trading income before you need to report it or pay tax on it. Unfortunately, employment income is not covered by this, meaning that you have to pay tax on your tips from the very first £1!
Cashless tipping is becoming more common. Methods of cashless tipping include apps which customers can download to make tips, and links or QR codes that customers can use to make tips. Sometimes there might be a physical terminal that customers can tap with a contactless card.
HMRC have recently updated their E24 guidance on tips, gratuities, service charges and troncs to confirm that the basic principles apply to cashless tips. This means:
Where cashless tips are received, managed and then distributed by the employer, the employer must operate tax and NIC via PAYE – as they would for any other tips controlled by the employer.
Where cashless tips are pooled and then processed via a tronc, then the usual tronc rules will apply.
Where cashless tips are paid directly to the employee without the employer’s involvement (for example by the app) – then these are treated like cash tips. The employee will need to declare them to HMRC. We understand that the customer usually pays any fees for making an electronic payment, however, sometimes fees or commissions may be paid by you. Although they may be deducted from your tips before they are distributed to you, it is our understanding that strictly, you should be declaring the gross amount to HMRC (that is, the tips before any deductions). We will seek to clarify this point with HMRC.
What if I am self-employed?
Tipping is common in many lines of self-employed work. If you are a self-employed tradesperson, beautician, driver, online performer (or anything else!) it is important to include all tips you receive in your sums when working out your self-employed income for your tax return. This includes tips from cash, cards or electronic apps.
If you are on tax credits, tips included on your tax return should be automatically included when your claim is calculated by HMRC. If you are on universal credit you should make sure tips are included in your monthly assessment of self-employment income when you report the figures to DWP.
If you have a main job (an employment) but make some tips from doing something different on the side, then it may be possible to use the trading allowance. But what if you have an existing self-employed business and make some tips by doing something different on the side? If it is only a small amount, can you use the trading allowance?
Sadly not. As we say above, the trading allowance can cover up to £1,000 of miscellaneous or trading income. However for the purposes of the trading allowance, the income from all an individual's activities (such as casual earnings and self-employment income) is combined.
So, say Jason is a self-employed carpenter and earns £30,000 a year (from having sales of £34,000 and expenses of £4,000) but at the weekend, he plays gigs in local pubs and receives some tips. Over the course of a year, the tips total £800. Once you add together the money from the carpentry and the money from the tips, it is more than £1,000 so Jason can’t use the trading allowance to cover the tips. This is even though the income is from a completely different type of work and the nature of the money is different.
Where you have miscellaneous or trading income over £1,000 you can deduct the amount of the trading allowance instead of actual expenses, which can help save you money. However Since Jason is already self-employed and has expenses above the trading allowance, this doesn’t work either.
There is information on our page ‘What is the trading allowance?’ which includes examples if you have more than one source of trading, causal or miscellaneous income.
Contact: Meredith McCammond (click here to Contact Us)
First published: 20/07/22