Unclaimed Cash Tips Can Cost Beauty Professionals More Than They Think

Today’s topic is a little bit dicey. I’ve only ever received hate for something I’ve posted on social media one time and it’s about this topic in particular. For some reason, beauty professionals feel very strongly about it, but regardless, it’s something important I think everyone needs to know. So, I’m gonna share all the details and have a conversation about it with you today – the topic is claiming your tips.

How Likely Am I To Get Audited?

The first question someone asks when they need to claim their tips is – how likely am I to get audited. And, I just want to start off the conversation by saying, that’s the wrong question to be asking. First of all, an audit is not planned, it’s a surprise. So we don’t know how likely you personally are to be audited, but more importantly, when you’re looking at something like this I think it’s important to look at your values and ask yourself, what kind of business owner do I want to be…

Do I want to be an honest business owner who does things properly and knows that when the tax returns are due, they are accurate and correct? Or do I want to be a business owner who maybe will make a quick buck on the side because they haven’t claimed something and always have that tax return hanging over my head. 

We’ll talk more about other possible consequences of not claiming your tips, but the thing about an audit is that less than 3% of people are audited and in a lot of cases it’s even less than 1% depending on the type of tax return that you’re filing. But, just because you may not be audited doesn’t mean that you shouldn’t still claim your tips. Audits are this mysterious thing that happens, but we don’t know why, how, or when. 

The IRS Has a Manual Specific for Beauty Pros

The first thing that you should know about an IRS audit is that they have a manual specific for beauty professionals. They recognize that cash tips are a commonplace practice within the industry and they have audit procedures specifically for this issue. Sometimes people think that they can get away without claiming their cash tips, but the fact is that even if you don’t deposit those funds into your bank account, there are still ways that the IRS can find those funds. So obviously, if you’re depositing the cash into your bank account and that cash isn’t being recognized on your tax return, that’s a no brainer. But, let’s say you don’t even put the cash into your bank account. What other ways can the IRS know that you’ve been receiving cash tips and neglecting to claim them? 

First, the fact that you have zero cash tips ever claimed is something that they’re going to look at – it’s a red flag. I recognize that these days there are some beauty professionals who are strictly credit card only and never accept cash in their business. I wouldn’t be concerned if you run that type of business, but I will say that it’s something that the IRS would look into a little bit more. 

Does Your Compensation Reflect Your Lifestyle?

Another detail the IRS can take a peek at is your lifestyle. They can take note of what type of house you live in, the type of car you drive, etc and they’re going to say — Okay, this is how much income Jessica makes based on her tax return, but we know to be able to afford that type of lifestyle, she would need to have a higher income. How you live versus what your tax return reports, will stand out as a BIG red flag to the IRS. If they notice on top of this that no tips are being recorded, they’ll go to your appointment book and investigate for themselves. 

For example, they can see on Saturday at 2pm, Sally came in for an appointment and either she paid completely in cash because there isn’t a revenue transaction whatsoever showing up OR she paid in credit for the service but then cashed out the tip, but you didn’t claim a cash tip. 

If the IRS starts to notice a pattern of your clients never tipping, that will validate their initial red flag that you haven’t been claiming your cash tips. So, just because you think that you’ve gotten away with something, be aware that there are other ways the IRS can figure it out. 

They also have the authority to calculate what they think you owe based on what they think you would have made in cash tips. They can then add that amount to your income, so it’s to your benefit that you claim your cash tips! It’s not nice to have to pay penalties and interest on a dollar figure that may be more than what you actually received.

What Happens If I Get Audited?

If you’re going to go through an audit, you don’t want to do that by yourself. You’re going to want an attorney and you’re going to want an accountant to represent you through that process. And my friends, that is not cheap. At minimum you’re looking at $10-$15K in services for representation. When you are claiming all of your tips, you’re actually protecting your business and really solidifying it as a legitimate establishment that runs honestly and properly. 

Employees of Salons Should Also Report Cash Tips

Let’s talk about salon owners who have employees because we all know that things have gotten crazy with Venmo, Zelle, and Cash App — all of these alternative ways that the clients of your salon might be paying your employees and you have no idea! 

Here’s the problem – as a salon owner, it is your responsibility to get the cash tips onto your employees payroll and W-2s at the end of the year. So here’s what you gotta do. You have to have a system in place within your business for your employees to tell you how much they received in cash tips. If you don’t have a process like this and you get audited, the IRS is absolutely going to dig in and look for missing cash tips. 

It won’t be enough to just say, oh yeah, we have this process. Maybe it’s on paper as a process but as a daily habit, no one‘s actually reporting what they receive. Every single day you need to be checking – have all of your employees reported any cash tips that they received? All those cash tips have to go onto the paystub. As a salon owner you’re not double paying out to them again. You are simply making sure that the taxes get withheld. 

Now, salon owners are in a bit of a shaky place here because it is so common, especially after the pandemic, for clients to just directly Venmo or Zelle that kind of thing. Tips submitted electronically via a third party service are no different than if they had received a cash tip. But, here’s where things get a little dicey. 

Venmo is starting to track payments for 1099s and if your employees are having a high volume of transactions in their Venmo where they’re receiving these funds, it’s possible that their account might get flagged to Venmo as a business account. Now mind you, they don’t own a business. They’re just employees and they shouldn’t even have a business Venmo account, but because of the volume of transactions and especially with descriptions, it’s going to be pretty obvious that there’s some kind of business relationship going on. Your employee(s) could get a 1099 from Venmo. You also have to fulfill your responsibilities which is to make sure that the tip income ends up on the W-2. In addition to the 1099 from Venmo, they’re also going to have that income showing up on their W-2. Cue problem because now they have documents showing duplicated income. That has to be sorted out with their tax accountant, which gets messy. 

Not Claiming Tips Deflates The Beauty Industry 

In addition to being honest and running a legitimate business there are other reasons to claim tips on your tax return and here’s one: not claiming your tips actually deflates the beauty industry as a whole. It makes everybody look bad. It makes you look like you’re not running a legitimate business which gives a poor perception to the community and everyone that you’re serving. AND in 2022, the average hairstylist made $28,000 a year according to salary.com. Like, what?? Friends, the average American made about 54,000 last year, so we’re looking at a little bit more than half of what the average American makes. I think there are two things going on here. The first is that when people aren’t claiming their tips, it makes the industry as a whole look like it’s not a good career for people and instead makes it look like a back up plan or side hustle. The second is that, when you are serious about your business and are running it like a legitimate establishment, there’s so much more money to be made. Your business has so much more potential than that average. 

The other thing people always tell me is — you know so-and-so said they don’t claim their tips and like, I just don’t know anyone who really claims their tips. Listen, I went to beauty school. I know what people say about tips. I also know what I was taught and told in beauty school, but here’s the thing. There comes a point where you have to ask yourself – Do I want to be average and make $28,000 a year like everyone else OR do I want to be different and really reach my goals. The moral here is that if you’re not claiming your cash tips, you’re actually making the industry as a whole look bad both in perception as well as in actual dollars reflected by surveys. 

A systemic issue surrounding not claiming tips is the impact on how people pay for beauty school – subsidized loans and grants. If the beauty industry looks like it’s not a viable career where graduates aren’t going to make enough money to pay back what they borrowed, how long are those grants and loans going to be available for students to attend beauty school? 

Not Claiming Tips Affects Big Milestones

Someday you’re going to need to retire. You’re not going to be behind the chair for your entire life and you’ve got to set money aside to be able to do that. A lot of retirement payment plans are based upon a percentage of your income, so when you claim less it actually allows you to put less towards your retirement. 

How else can not claiming your tips impact you? Let’s see, how about loans! The amount of loan that you can get approved for is directly related to how much income you’re bringing in. For example, unless you’re rolling in money and you don’t need a loan to buy a house you’re gonna need a little bit of help. So, when you say you make 20% less than what you actually make, that means you’re not going to be able to buy either as big of a home, as nice of a home or even a home at all because you’re not claiming everything. 

As sad as this is, I’ve even heard of stylists not getting approved for even small loans, like for vehicles, because they’re not claiming enough on their returns and can’t prove that they’re making more money. If you sit down with a loan officer and you say – I know my tax return says I only made $15,000 last year, but actually I have all this cash and I’m making way more money…. that’s never going to fly because it’s obvious that you’re committing fraud and they DO NOT want to be a part of that. So listen, if you want to buy a new car someday or your dream home, you have to make sure that your income is as high as possible so that you can get as large of a loan as you need!

There you go my friends, this is why you should be claiming your cash tips whether or not it’s convenient and whether or not you enjoy paying taxes. If you’re running an honest and legitimate business, you need to make sure you are on top of claiming those tips every single year. And hey, nobody likes doing it, but it’s the right thing to do!