By: David Herzig
Yesterday on Twitter, Scott Greenberg (@ScottElliotG) posted the following tweet from Matt Bruenig.
Well, David Gamage, Omri Marian, Andy Grewal and I had fun in 120 characters debating the quality of the tax advice provided on both the receipt and the note. Suffice to say: (A) this will be appearing on a number of basic income tax exams shortly; and, (B) neither piece of advice provided by “Mr. Libertarian” seems to be correct. Both David and I pointed out that the “tip” did not seem to meet the old Duberstein detached and disinterested test. Clearly there was a quid-pro-quo; don’t spit on my food and I will give you extra money in addition to the bill.
Joking around about the gift/income distinction made me think that tipping is very tax inefficient. Assuming that what I said is true: tips are not gifts and they are income to the recipient. This means that the payment is not deductible by the payor (just personal consumption) yet income to the recipient, i.e. the server. If it is ordinary income to the recipient, then there should be a corresponding wage deduction, right?
Let’s assume the following counterfactual. The restaurant includes the tip as part of the bill. The restaurant pays the employee salary including the entire tip. Under this structure, the restaurant would receive an entire wage adjustment for the tip paid. The customer is still does not receive a deduction for paying the employee’s wages and the employee still pays the same amount of income tax. But the employer captures the unused deduction for wages by the customer. Theoretically, this deduction could be shared by all the stakeholders to reduce costs to all parties.
Who cares? Well, only economists and tax professors, probably. Back to finals preparation!
 Here is David Gamage’s hypo: customer leaves $1K and says, I just won the lottery and want to share some of my winnings as a “gift”.