What Are the Tax Consequences When You Get or Leave a Huge Tip?

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If you’re a fan of human interest stories, you’ve probably seen articless about celebrities leaving an enormous tip.

And if you’re one of money expert Clark Howard’s podcast listeners, you may have wondered about the tax implications of outsized tips.

On the Jan. 3 podcast, Martin in Vermont asked if tips “many times larger than the entire cost of the meal … have to be reported as income to the IRS? Or can [they] be treated as a gift?”

According to Clark: “You’re allowed to give any individual up to $16,000. That does not cause a gift tax problem for you and does not cause an income tax issue for them.

“I think that when somebody gives a very, very, very large tip, it would be considered to be in that gifting category. Because in no way would it fit a normal business event that someone would get a tip of $1,000, let’s say, on a $12 meal.”

Consumer Action Center volunteer Cecelia Armstrong is a retired CPA who spent a lot of time working on taxes during her career.

Armstrong agrees with Clark’s response to the listener’s question. A tip of thousands of dollars on a dinner bill of less than $100 seems more like a gift than a normal 20% gratuity.

“The IRS probably would want to fight that just because they like to think that any time money changes hands it must be a taxable transaction,” Armstrong says. “But it should be a gift when it’s astronomically large. Because it doesn’t even appear in essence to be a tip.”


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Big Tips: Impact on the Person Tipping

If you’re the one dishing out the tip, you don’t have much to worry about from a tax standpoint. You should, however, be aware of a simple IRS rule.

You’re allowed to give a gift — cash or otherwise — of up to $16,000 in 2022 to any individual without paying a cent in taxes on that gift.

That’s probably far more than the cash you may slip into a gift card for your cousin’s birthday. But hey, if you decide to start writing checks for more than $16,000, let me know. I’d be glad to accept!

Gifts to individuals are not tax-deductible.

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Perhaps more realistically, you’re reading because you’re curious about what happens with the generous and absurd tips that you read about on social media.

Even if a person were to tip $20,000 on a meal, it’s unlikely he or she would pay taxes on the $4,000 above the allowed amount.

As of 2022, the lifetime annual exclusion is $12.06 million. So in this instance, the giver could apply the additional $4,000 to their lifetime exclusion and be left with … $12.06 million (after rounding up). That number doubles to $24.12 million for married couples.

The more gifts you apply to your lifetime exclusion, the less tax protection you’ll have to apply to your estate. Of course, many of us won’t ever approach double-digit millions of dollars.


Big Tips: Impact on the Person Receiving the Tip

Let’s turn our attention back to servers receiving unusual tips at restaurants.

The tax circumstances can get murky fast, Armstrong points out.

Each restaurant has its own system when it comes to tips. Some restaurants expect workers to report and even divide cash tips.

Tips are taxable. So any tip money that makes it into the restaurant’s accounting system and gets classified as a tip should get reported to the IRS.

When a Restaurant’s Accounting System Labels a Gift as a Tip

Gifts of less than $16,000 don’t need to be reported to the IRS. But if the restaurant forces the employee to count the money as a tip, things get complicated.

A tip made national news recently when a group of diners left a $2,200 tip for two waitresses in Arkansas. The restaurant demanded the waitresses split the tip with the rest of the staff and eventually fired one of them (claiming the dismissal wasn’t related to the drama).

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If the tip gets charged to a credit or debit card as an add-on cost to the meal, it could easily enter the restaurant’s accounting system.

“Once it gets into the restaurant’s bookkeeping that it was a tip and that it went here to the busboy and here to the cook and the bartender and everything, it loses totally its gift status,” Armstrong says.

“Then it’s just another line item. It doesn’t say, ‘Oh my goodness, this is more than 50%, it must be a gift.’”

If that happens, the restaurant will report the money to the IRS as income at the end of the year. Even if the employee gets full credit for the tip and doesn’t have to split it, the IRS is getting documentation from the restaurant that it’s a tip, not a gift.


Famous Tips in the News

All this talk of gigantic tips that you can claim as tax-free gifts may give you the urge to go work at a restaurant.

But, at least based on mainstream news reports, waiters and waitresses rarely get life-changing tip money. The smart ones probably aren’t posting on social media if they do.

Shaquille O’Neal once tipped a waitress $4,000. That’s a lot of money to give to a stranger. But in the grand scheme of things, the fact that it made national news is indicative of the rarity of this type of act.

Charles Barkley once tipped $25,000 … to a casino dealer after winning a lot of money.

It may be more likely that the Holy Grail level of tips occur when celebrities are cutting loose. Jay-Z supposedly once left a $50,000 tip on a $250,000 bill at a Miami nightclub.

For us normal folks, a 20% tip is still generous. Clark says he continues to tip a normal amount despite some of the changes to the restaurant industry in recent times.

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