I’ve worked many years for tips. I began my restaurant career when I was 14 (don’t tell the Labor department). I’ve been a busboy, a waiter, a bartender, and manager. My brothers were chefs, my sisters waitress’ and my father was a restaurant owner who worked in restaurants all his life.

I guess I feel it’s important to share some of my personal history right up front so that what I write next has some context. And what I want to communicate is this: the single most important issue facing restaurant owners today, and the absolute bane of their existence, is the handling of tips.

How did we get to a point where tip reporting looms so ominously over the heads of restaurant owners? And more importantly, what can we do to protect ourselves from an aggressive Department of Labor, IRS, whistle blower employees and litigious class action lawyers?

It really goes back 20 years to when Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA).The admitted purpose of TEFRA was to generate additional revenue through a combination of spending cuts, tax increases and reform measures. One area targeted was tip reporting. According to the IRS, at the time of TEFRA, only about 15% of restaurant and bar employees were accurately reported their tip income. The Act “encouraged” employers to make sure that their tipped employees are complying with “their” reporting responsibilities. Funny, but I never hear of a tipped employee being heavily fined for not complying with “their” reporting responsibilities. Instead, the restaurant owner receives the fines for not “encouraging” them well enough!

By definition, the tip is deemed a transaction that occurs directly from the customer to the employee and the management and ownership may never receive any part of that tip. Think about that: restaurant owners cannot derive any monetary benefit whatsoever from tips and are held responsible for handling all the reporting of tip income for all of their tipped employees. That often means incurring extra costs for bookkeeping and recordkeeping, as well as management oversight to make sure the reporting is airtight. Still, no matter what, they have to make sure it is accurate. Why? Because the first records an investigating agency will look for are your payroll records.

TEFRA also imposed a myriad of complex regulations as to who could share in the tip transactions. The age-old industry practice of tip pooling and tip sharing invites many additional headaches. The job categories that are permitted to share the tips in the pool, and at what percentage, are heavily regulated. As discussed earlier, owners and managers are never permitted to share in the pool. Other employees such as bus people, bar backs, service bartenders, food station workers, and others may be classified as indirectly tipped employees and allowed to share in a percentage of the tips. Again, the payroll records will be what the restaurant will stand upon, one way or another.

So, the government actually holds the restaurant owners accountable for properly reporting income that isn’t even theirs! As one restaurant owner client of mine said to me: “This is the area where we have the most amount of risk, and the least amount of control. How do you successfully navigate a crazy arrangement like this?”

And today, the level of exposure has never been higher. In the past, you had to contend with an investigating government agency and maybe a lone disgruntled employee. Now, you can’t read a newspaper or a trade magazine without reading about the latest restaurant owner who settled a class action suit brought against him by this new class of lawyers who have built very lucrative practices organizing restaurant workers against their employers. So owners aren’t just being squeezed from two sides—government agencies and lone employees—but from three! And these lawyers are often going after the high profile restaurateurs. The client I quoted above went on to say: “Success, fame and celebrity make you a target." These lawyers are going after high-profile restaurants and entrepreneurs because they know they’ll almost always settle. First, to minimize their legal fees, and next, to avoid the defaming publicity.

I can’t even count how many restaurant owners I’ve encountered who got into trouble around tip reporting because they didn’t get the proper counsel on how to navigate this critical issue. And the first thing I tell them is, you must have workforce management systems—payroll, time and attendance, a POS system for revenue tracking, etc.—that are bullet-proof. Because like it or not, you are a target.

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