Is tax payable on tips?

The question of whether tips and gratuities are taxable and subject to National Insurance Contributions (NICs) often results in a lively debate. Broadly, their treatment will depend on how they are paid to the recipient.
Cash tips handed to an employee, or say, left on the table at a restaurant and retained by the employee, are not subject to tax and NICs under PAYE, but the employee is obliged to declare the income to HMRC.
Where HMRC believe that employees in a particular employment are likely to have received tips which have not been declared, they will generally make an estimate of the tips earned on the basis of facts available to them. HMRC often make an adjustment to an employee’s PAYE tax code number to reflect the amount likely to be received during a tax year and the tax and Class 1 NICs due will be collected via the payroll.
By contrast, if an employer passes tips to employees that are either handed to them (or the employees) or left in a common box/plate by customers, the employer must operate PAYE on all payments made. Tips will also be subject to PAYE if they are included in cheque and debit/credit card payments to the employer, or if they pass service charges to employees.
The obligation to operate PAYE remains with the employer where the employer:
• delegates the task of passing the tips or service charges between employees, for example to a head waiter in a restaurant; or
• passes tips/service charges to a tronc (see below) but the tronc is not a tronc for PAYE purposes.
Examples
Marcia, a restaurant owner, passes on all tips paid by credit/debit card to her employees. She has made a payment to her staff and must operate PAYE on these payments as part of the normal payroll.
Franco, also a restaurant owner, allows all cash tips left on tables to be retained in full by his staff. However, to ensure the kitchen staff receive a share, he collects all the cash tips and shares them out to the staff at the end of each day. Franco is involved in the sharing out of the tips and he must therefore include the amounts received as part of the payroll and operate PAYE on them.
Troncs
Where tipping is a usual feature of a business, there is often an organised arrangement for sharing tips amongst employees by a person who is not the employer. Such an arrangement is commonly referred to as a ‘tronc’. The person who distributes money from a tronc is known as a ‘troncmaster’. Where a person accepts and understands the role of troncmaster, he or she may have to operate PAYE on payments made. Broadly, under such arrangements the employer must notify HMRC of the existence of a tronc created and provide HMRC with the troncmaster’s name.
There are no hard and fast rules regarding how a tronc should operate and HMRC will apply the PAYE and NIC rules to the particular circumstances of each tronc. Where payments made from a tronc attract NICs liability, responsibility for calculating the NICs due and making payment to HMRC rests with the employer. If a troncmaster is responsible for operating PAYE on monies passed to the tronc by the employer and has failed to fulfil his or her PAYE obligations, HMRC can direct the employer to operate PAYE on monies passed to the tronc from a specified date.
NICs
Legislation provides that any amount paid to an employee which is a payment ‘of a gratuity’ or is ‘in respect of a gratuity’ will be exempt from NICs if it meets either of the following two conditions:
• it is not paid, directly or indirectly, to the employee by the employer and does not comprise or represent monies previously paid to the employer, for example by customers; or
• it is not allocated, directly or indirectly, to the employee by the employer.
Review business records
It is worthwhile checking that businesses treat tips and gratuities correctly. From time to time HMRC carry out reviews of employers’ records to make sure things are in order for PAYE, NICs and separately for the National Minimum Wage (NMW). Any errors in tax and NICs treatment could prove costly.

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Abatement of the personal allowance

Not all taxpayers are able to benefit from the personal allowance – once income exceeds £100,000 the allowance is gradually reduced until it is eliminated in full. However, there are steps which can be taken to reduce income and preserve entitlement to the personal allowance.
The personal allowance is set at £11,850 for 2018/19, rising to £12,500 for 2019/20.
When is it abated?
Once an individual’s ‘adjusted net income’ exceeds £100,000, their personal allowance is reduced by £1 for every £2 by which ‘adjusted net income’ exceeds £100,000.
The measure of income for these purposes is ‘adjusted net income’. This is an individual’s total taxable income before personal allowances and after deducting certain reliefs, such as:
• relief for trading losses;
• donations to charity through the Gift Aid scheme (deduct the grossed-up amount of the donation); and
• pension contributions (deduct the gross amount).
Example
Polly has taxable income for 2018/19 of £120,000. She makes pension contributions paid gross of £5,000.
Polly’s adjusted net income for £2018/19 is £115,000 (£1250,000 – £5,000).
As her income is more than £100,000, her personal allowance is reduced. The personal allowance for the year of £11,850 is reduced by £1 for every £2 by which her income exceeds £100,000.
The reduction in her personal allowance is therefore £7,500 (1/2(£115,000 – £100,000).
Her personal allowance for 2019/20 is therefore £4,350.
Assuming her income remains the same for 2019/20 and she continues to make gross pension contributions of £5,000, she will receive a personal allowance of £5,000 for 2019/20.
When is the personal allowance lost?
With a personal allowance of £11,850 for 2018/19, individuals with income in excess of £123,700 do not receive a personal allowance for that year. For 2019/20, the personal allowance is £12,500, and the personal allowance is lost once adjusted net income exceeds £125,000.
Beware 60% tax in the abatement zone
Where adjusted net income falls within the zone in which the personal allowance is reducing – from £100,000 to £100,000 plus twice the personal allowance – the marginal rate of tax is 60%. This is the combined effect of the application of the higher rate of tax and the reduction in the personal allowance.
Reduce the 60% band and preserve the allowance
To reduce the income falling in the abatement zone (taxed at a marginal rate of 60%) and to preserve as much as the personal allowance as possible, it is necessary to reduce adjusted net income.
There are various ways in which this can be achieved.
The first point to consider is the timing of income – can income be deferred to the next tax year, or, if income for the current tax year is less than £100,000 but is expected to be above £100,000 in the following year, can income be brought forward to the current tax year. In a family company scenario, it may be possible to achieve this by adjusting the timing of dividends and bonuses.
Consideration could also be given to putting income earning assets into the name of a spouse or civil partner to reduce income and preserve the allowance.
Adjusted net income is income after pension contributions. Making pension contributions is tax effective, both in terms of benefitting from the relief available and reducing net income to preserve personal allowances.
Alternatively, a person can make charitable donations under gift aid to reduce their adjusted net income. Although they will lose the benefit of their income, the cost will be offset slightly by the preserved personal allowance, and their chosen charity will be benefit from the donation plus the associated gift aid.

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