One of the greatest benefits of the beauty industry is the opportunity to grow your career in any direction you choose, including fulfilling the dream of becoming a business owner. But with growth and success come greater responsibility, including educating staff, tracking revenue and expenditures, and following income reporting and tax laws.
Sounds simple enough, right? The truth is many salon owners don’t know what is mandatory, and are often surprised when faced with the consequences of not doing it correctly, including costly lawsuits and IRS audits.
Salon owners with employees that accept tips are responsible under federal law to track and report those tips to the IRS and pay their employer share of FICA taxes (Social Security and Medicare) on those tips. And, perhaps most importantly, keep detailed records of it all.
Beware the Tax Man
Imagine coming in to your salon on a morning like any other and finding an IRS auditor waiting with a list of financial reports dating back years that you are now responsible for gathering. Daired Ogle, 34-year owner of Daired’s Salon and Spa Pangea in Texas, experienced this first hand after discovering that he was under an IRS investigation.
“[They] wanted to see how many tips were paid with cash and how many were on credit cards. Our software does not have reporting capabilities that separates those two transactions,” Daired explained.
The audit lasted for three days and the auditor went through financial records, interviewed management, and conducted random interviews with service providers. Some of the documents requested of Daired included:
- Payroll ledgers
- Registers and journals
- Forms, including W-2s, W-3s, 1099s, 1120s, and 1040s
- Daily and monthly sales reports
- Personal manuals
- Bank statements and cancelled checks
- Copies of credit card batch reports
And the list goes on. To make it more complicated, this information went back for two full years. Without professional record keeping and impeccable files, collecting these types of documents would be a nightmare for a busy salon owner.
Although Daired has always tracked, reported and paid the required taxes on his employees’ tips, he is cautious to make sure to always look at the fine print.
“Monitor tipping and keep good records because ultimately the business is responsible,” he said “We have changed the way we report tips and have taken the extra precaution of having staff keep a daily journal of any tips that might have been paid to them directly.”
Danger Could Be Closer Than You Think
If you think the IRS should be your only focus, you are wrong. Beyond proper reporting and IRS compliance, you must first implement proper tip procedures in your salon. Employee lawsuits can have just as much, and sometimes more, impact on your bottom line than the IRS.
After a conflict over non-compete agreements with three stylists turned into a legal battle over credit card tip fees, Oliver Steinnagel, owner of Oliver’s Hair Salon in Kansas for more than 20 years, learned a hard lesson.
The stylists sued for the withholding of an administrative fee from credit card tips. Although salon owners are allowed to recoup the fees associated with credit card transactions, that amount is limited. As of May 2011, employers can only withhold the amount charged by the credit card company. Oliver didn’t know about this new law and after three months gathering documents and hiring a tax attorney, Oliver repaid the difference to all staff. “The suit to date has cost us over $40,000. What a lesson!”
The Silver Lining
Is the whole idea of salon ownership sounding grim? It doesn’t have to be. Staying informed on current laws and educating your staff on the importance of proper tip reporting is fundamental to protecting yourself from audits and lawsuits.
Kendall Ong, owner of Mane Attraction in Arizona, makes education of his staff a priority. Adamant about incorporating tip reporting education into his training program, stylists are told how and why they are required to report tips. Compliance is discussed with each employee.
“Our job as owners is to look after the well-being and future of our employees. It elevates the industry and it’s the ethical thing to do.”
It’s not always easy to do the right thing and be compliant with tax laws. But, if you’re passionate about the industry and the future of your employees, you can lead by example.
“We pay approximately $12,000 - $15,000 in payroll taxes on tip income every year. With the passage of the FICA Tip Tax legislation, this money could be reinvested into our salon and staff,” expressed Kendall. “The long term benefits of compliance are that we will see our industry grow.”
Myra Irizarry is the Director of Government Affairs for the Professional Beauty Association (PBA)