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Financial Planning for the Cash Based Professional

Let’s set the scene. You are an awesome bartender—visualize, Def Leppard playing on the juke box, beautiful bartender standing on the bar as she is spraying the wild crowd in beer (happily). Yes, that is the scene from Coyote Ugly, and yes, Violet Sanford is one of the awesome bartenders from that movie. On a side note, I disagree with the current 22% rating from Rotten Tomatoes, but we can save that for a different time.

As a tremendous bartender, you receive a lot of cash in the form of tips. Most of the time with any cash based business, Uncle Sam may not get the “full picture,” if you get what I am saying. Now, as a CFP®, I would urge you to report every dollar, but I also know that doesn’t happen.

This blog was built from a great question from a good friend of mine. After reading one of our blogs, he suggested writing a blog for bartenders and the service industry. They are the opposite of cash strapped, but they don’t know what to do with the cash. He noted that more often than not, we [service industry] stash it away in our mattress and end up wasting it on silly purchases. It is a wonderful question, and I think it pertains to any cash based business.  Both of my parents ran small businesses, and they were almost all cash businesses.

Full disclosure: The service industry is not my niche; however, I was shocked by the lack of resources that were available to help with this question. Besides tax fraud and tax evasion articles, there were not many resources. Hopefully this will be a valuable starting point for cash based individuals.

Underreporting Income Has Large Effects

In today’s world, your tax history plays a pivotal part in a lot of things. The biggest we see on a day-to-day basis is your mortgage. When you apply for a mortgage, or even refinance, your tax form 1040 is going to be heavily weighted in the lender’s decision making process. The lender is not going to take your word when you drop this line, “hey, I know my 1040 shows $50,000 in income last year, but I earned an additional $20,000 in cash tips that I didn’t report.” That won’t go over well with your lender or the IRS.

Another bad idea is to show a fake tax return to a lender, where you added your tips all of a sudden. Almost every lender will have you sign a 4506-T, this will allow the lender to get a copy of the FILED tax return to make sure it matches what you sent.

It is a good idea to start reporting your cash sooner than later. Most mortgage lenders will want to see two years of tax returns. You don’t want to say you were a bartender for the past 5 years and only show tips the most recent year. The lender will want to see consistent income.

Also, these same rules apply to a car loan, personal loan, and anything else that requires proof of income.

The obvious downside of underreporting income would be the IRS finding out. Tax fraud can lead to penalties, and on a bad day, prosecution (fraud and tax evasion).

In summary, not reporting or underreporting income is BAD. It can also have an affect on many other financial items.

Tax-Deferred Is Better Than Tax-Fraud

Start reporting your income, all of it! What if I told you there was a way to “hide (aka tax-deferred)” $23,500 of your income on your taxes legally each year? I am going to use a cookie-cutter model here with some assumptions. If your employer offers a 401k, you can save up to $18,000 per year (2017). This $18,000 won’t be taxed today, but it will once you take withdrawals down the road. You can also open up an IRA for yourself and save another $5,500 (2017). The IRA won’t be taxed today, but it will be taxed upon withdrawal. Full disclosure, your IRA deductibility will depend on your income (Modified Adjusted Gross Income) and filing status.

So we just removed $23,500 from your mattress, it now shows on your 1040, and you still didn’t have to pay taxes on it. The $23,500 will be tax-deferred, and yes, eventually you will have to pay Uncle Sam.

If you are feeling sparky, use the above scenario, but utilize a Roth 401k and a Roth IRA. You WILL be fully taxed on that income for the current year. However, you will not have to pay taxes on the money ever again as long as you follow the rules for a qualified withdrawal.

How to Claim Cash Tips on Your Tax Return 

After reading this, you said to yourself, Chad is right (thank you), I need to start claiming all of my income. Well here is how.

Step 1: Record how much tip income you bring in.

The IRS rule says you are to report your monthly tip income to your employer by the 10th of the following month. If your employer does not have this process in place, you can use a Form 4070. The Form 4070 may be the simplest form the IRS has ever made (thank the tax gods!).

Use a notebook or an Excel spreadsheet to track your numbers. Also, make sure you note any tips that are paid to others. For example, the busboy or another bartender. You only need to report the income you received.

Step 2: Check your W-2.

Make sure everything matches up. Keep in mind, if you underpay in taxes by more than $1,000, the IRS can add penalties. If this happens to you, you will either want to adjust your W4 with your employer or start to pay estimated taxes on a quarterly basis. This can get a little complicated, and it may be worth a visit to an accountant (preferably a CPA).

Step 3: Form 4137.

If you have months where your tips were less than $20 (less than $20 of monthly tips do not have to be reported to your employer), you would report them on the Form 4137. This is where you would pay Uncle Sam for the unreported months of $20 or less.

Fun Facts to End

  • Who knows where social security will be in a few years, but every year you underreport your income, it will have an affect on your future social security.
  • If you apply for a disability insurance policy, you may not get full coverage if you are underreporting your income. Very similar to the mortgage example, you can’t say you make $70,000, but only report $50,000. You are only going to get insured based on your 1040 income.
  • If you are a business owner in a cash based business, please show your income! If you go to sell your business to anyone with a brain, they are not going to “trust” that you make all this extra money in cash. Report it or don’t get paid for it!
  • Homeowners and renters insurance will typical only insure up to $200 in cash. If your house burns down, you get robbed or any other event that destroys your house, anything over $200 in the mattress is gone. Also keep in mind, depositing large sums of cash at your bank ($10,000+) will throw up more flags than a Raiders football game (Raiders 23-flags in one game).
  • Another good way to “hide” income legally is to take advantage of a Health Savings Account (HSA).

Even though tip income may seem small on a day-to-day basis, when you add it up it usually amounts to thousands of dollars each year. Report all of your income. It will improve your financial planning, you will look better to lenders, and you can sleep better at night knowing the IRS is not looking for you. Or if you come home and your house is in a blazing ball of fire, you won’t have to roast marshmallows over your life savings.

*Disclosures, so my compliance team does not have a heart attack:

  • The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions, and when sold or redeemed, you may receive more or less than initially invested.  
  • For ANY tax notes above, I am not an accountant or a CPA. Please be sure to consult an accountant or CPA before implementing. This blog does not constitute tax advice.
  • Registered Representative offering securities through Cetera Advisor Networks LLC, member FINRA/SIPC. Cetera is under separate ownership from any other named entity. Advisory Services and Financial Planning offered through Vicus Capital, Inc., a Federally Registered Investment Advisor.


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