The small business case for banning tips

New legislation has been proposed to help small businesses in the beauty salon industry. But I wish it weren’t necessary.

Being in the beauty salon business isn’t easy. There are overheads, insurance costs and scheduling headaches, and the regulations in the industry are mind-boggling: Many states from Georgia to Hawaii to Alabama and Arizona require thousands of hours of work by an individual person just to become a licensed cosmetologist. Remember, this is for a cosmetologist, not a cardiologist. 

And yet, even with these challenges, the number of independent beauty salons is proliferating, with one research organization estimating that the U.S. has almost 1.4 million hair and nail salon businesses, with as many as 80 percent of them being small businesses and a significant number of them being minority owned.

One thing that’s always irked the beauty salon industry is tips. Tipping in this industry – like in many industries in the U.S. – is, unfortunately, all too common. To help those in the food service industry, there is a tax incentive called the Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips (or the 45B Tax Credit, after its IRS code section). Beauty salon owners do not have this benefit, and the difference is costly. How so? Let’s do the math.

Let’s assume that a hair salon pays an employee $600 for 40 hours during a week in which they saw 25 customers. And let’s assume that each of these customers paid $75 for a cut and tipped the stylist 20 percent each time, so the stylist earned another $375 in tips. So, the stylist earned a total of $975 that week. The beauty salon owner would have to pay the employer’s share of FICA (7.65 percent) on all those earnings and would owe the government $74.59 for that employee.

But if that same salon owner could, like a restaurant, take advantage of the 45B tax credit, any tipped hourly earnings over a floor of $5.15 wouldn’t be subject to employer FICA taxes. Using the same example above, the excess of tipped earnings ($375) would exceed the floor of $206 (40 hours x $5.15) so only $169 would be subject to FICA tax in addition to the $600 in hourly earnings paid for a total of $769. Which means that the salon owner would pay $58.82 in employer FICA taxes instead of $74.59 for a savings of $15.77.

Doesn’t sound like a lot? Say the salon employs 10 stylists. That becomes a $157.70 savings per week or $7,885.00 savings per year, assuming a 50-week work year. That’s a lot for any small business owner.

Which is why a bipartisan bill – called the Small Business Tax Fairness and Compliance Simplification Act – has been re-introduced in the Senate to extend this complicated tax credit to the beauty services industry. 

“This critical tax code modernization effort will benefit small businesses, such as salons and barbershops, simply by creating a level playing field,” said Sen. Tim Scott (R-S.C.) in a joint press release with co-sponsor Sen. Ben Cardin (D-Md.).

The senators note that the bill has, not surprisingly, “broad industry support.” The credit is also supported by the National Taxpayers Union.

In addition to expanding the tax credit, the bill would lessen the regulatory burden on certain self-employed individuals by exempting them from IRS examinations as well as reporting and recordkeeping rules and shift these requirements to landlords.

All of this “modernization” is due to the convoluted and frustrating practice in the U.S. that is tipping. Isn’t there a better solution that would help small business owners? Wait, I know of one: Instead of piling on more legislation to “level the playing field” for small businesses, how about just one bill that makes tipping illegal?

Visit most other Western countries and you’ll find that tipping is unusual and oftentimes discouraged. (The befuddled looks I received from servers in London last month when I pressed on them a tip underscored my point.) But not in the U.S.

If tipping were legislatively banned here, a small business would have to pay their employees more. Is that a problem? Of course not. Small business owners would simply pass this extra cost on to customers. Will that raise prices? Yes. But isn’t that already happening now? Aren’t our customers already paying an extra 15-25 percent on their bill for tips?

Making tipping illegal makes tax compliance for small businesses much easier by eliminating the regulatory burdens imposed by federal, state and local governments that requires these businesses to record and report tip income. It would make complicated tax credits like the 45B unnecessary. It would eliminate potential conflicts between employees and employers and protect employees from being underpaid by cheapskate customers. It would make the payment experience faster, easier and less stressful for customers. It would be one little simplification in this ever-increasingly complex world.

But clearly, a law banning tips in the U.S. isn’t going to happen anytime soon. So, I guess that means small businesses in service industries will continue to have to deal with these headaches. And I can assure you that with the passage of the Small Business Tax Fairness and Compliance Simplification Act, other service providers such as hotels, transportation, taxi and cleaners will be next in line for similar relief.

Gene Marks is founder of The Marks Group, a small-business consulting firm. He frequently appears on CNBC, Fox Business and MSNBC.