Tips are taxable income, even when they come from gambling winnings

Gambling winnings in Canada are tax-free. Employees’ tips and gratuities are taxable. But what if you work in the gaming industry and a casino patron tips you after hitting the jackpot at the slots?

The Tax Court addressed that issue in a decision released last week involving a slot attendant at the Grand Villa Casino in Burnaby, B.C., who was reassessed by the Canada Revenue Agency for failing to report nearly $24,000 (in 2011) and $39,000 (in 2012) of tips as taxable income on his returns. He was also slapped with gross negligence penalties of $3,059 (2011) and $5,352 (2012) for omitting these tips from his income.

Prior to joining the casino in 1999, the taxpayer was a full-time financial adviser who sold mutual funds and life insurance. Once he began working at the casino, he transitioned to part-time advisory work.

His slot attendant duties included servicing the slot machines, contacting the appropriate casino employees when a patron won and wanted to cash out, showing guests how to use the machines when necessary, and “generally maintaining a friendly, positive attitude in interacting with casino patrons.” The taxpayer was paid an annual salary by the casino of $27,000 in 2011 and $29,000 in 2012.

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Occasionally, when patrons win a jackpot, they give some of their winnings to a slot attendant. But this casino’s employees were not permitted to keep the tips individually received. Rather, the tips were pooled and distributed to the attendants by a “Slot Tip Committee” on the basis of certain criteria, such as the number of hours worked in a given period. Two volunteers collected and tracked these amounts on a series of “tip spreadsheets,” which determined the eventual payouts to each of the approximately 40 slot attendants.

The taxpayer, who prepared his own returns, only included his casino salary in his income and deliberately excluded his tip income “because he theorized that the amounts he received were part of the source … of jackpot winnings that casino patrons had won … that are non-taxable gambling proceeds and are, therefore, not received by virtue of his employment.”

The CRA disagreed and reassessed him to include the unreported tips in his income stating “these amounts were received from patrons by virtue of his employment as a slot attendant at the casino.”

The judge started her analysis by turning to the Income Tax Act’s rules regarding employment income. The act states “a taxpayer’s income for a taxation year from an office or employment is the salary, wages and other remuneration, including gratuities, received by the taxpayer in the year.”

The legislation goes on to state that “benefits of any kind whatsoever received or enjoyed by the taxpayer … in respect of, in the course of or by virtue of the taxpayer’s office or employment” must be included in that taxpayer’s income.

As the judge observed, the wording in the act is “straightforward, but it is also very wide in its scope as to what constitutes income. In other words, it casts a very wide net and specifically includes gratuities received by a taxpayer.”

Rejecting the taxpayer’s arguments that the tips should be tax-exempt because they were gambling proceeds, the judge distinguished between the money won in the hands of the gambler and the money turned over to the attendant. A jackpot winner doesn’t have to pay tax on any winnings, but when part of these winnings are then paid to a casino employee in recognition of the services that the patron received, “the nature of that amount changes from being non-taxable to a taxable amount in the hands of the employee.”

The judge analogized the situation to a casino patron tipping a server in a restaurant using proceeds of his jackpot win. Clearly, the server’s tip would be taxable income to the restaurant employee and not deemed to be tax-free gambling proceeds.

The taxpayer, somewhat versed in tax matters from his days as a financial adviser, also attempted to argue that the tips he received were “similar to the payment of (tax-free) life insurance proceeds that might be gifted or shared with a friend or family member.” The judge disagreed and said a tip received by a casino employee was “not a gift but is simply a tip or gratuity for the services rendered” by the slot attendant.

The judge then turned to the issue of whether the gross negligence penalties assessed by the CRA were appropriate. Prior jurisprudence has developed a number of factors that distinguish between “ordinary negligence” and “gross negligence,” including: the size of the omitted income compared to a taxpayer’s declared income, the opportunity for detecting the error and the taxpayer’s “education and intellect.”

It was perhaps this last factor that proved the taxpayer’s ruin. The judge stated the taxpayer “came across as a highly intelligent and well-educated individual” with a master’s degree in public health from Emory University and a bachelor of medicine. His work experience as a financial adviser included providing “investment, tax and financial advice.”

Upon cross-examination, the taxpayer stated he had knowledge of the associated tax benefits and consequences of the various financial products he sold, and acknowledged that payments had the potential to change from non-taxable to taxable. For example, he knew how tax impacts life insurance proceeds differently than mutual funds.

Yet despite all this education and tax background, the judge said the taxpayer “made no effort” to determine whether there was any legitimate basis for excluding the tips from his income. He did not make any inquiries with a CRA official, accountant, bookkeeper or lawyer, but “simply adopted an interpretation that was most favourable to his circumstances.”

Given that the unreported tips were “very significant and material” compared to his reported income, the judge felt the taxpayer should have “made some effort to ascertain the proper tax treatment of such large gratuity amounts.” Instead, he “displayed a dismissive and indifferent attitude toward the reporting of these tip amounts without regard to the potential consequences. Such behaviour goes beyond ordinary neglect or carelessness and lands the (taxpayer) into the realm of gross negligence which justifies the imposition of these penalties.”

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Jamie Golombek, CPA, CA, CFP, CLU, TEP is the managing director, Tax & Estate Planning with CIBC Financial Planning & Advice Group in Toronto.