IRS Automatic Tip Gratuities for the Hospitality Industry

By usapayroll
In June 25, 2014
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Effective January 1, 2014

Automatic gratuities in the hospitality industry (for example, an automatic 18% tip for parties of six or more) will be treated by the IRS as service charges rather than tips. Unlike optional tips which the employee bears the responsibility of reporting, these service charges will be viewed as wages and employers will be responsible for reporting them. Additionally, employers should be aware that any such service charges will be considered part of the employee’s regular rate of pay for purposes of calculating the overtime rate.

Per the IRS, in order for a payment to be treated as a tip, generally all of the following factors must be met:

  1. The payment must be made free of compulsion;
  2. The customer must have the unrestricted right to determine the amount of the payment;
  3. The payment may not be dictated by employer policy or be the subject of negotiation; and
  4. Generally the customer must have the right to determine who gets the payment.

If any of these factors cannot be satisfied, the payment is likely a service charge.

For example, ABC Restaurant’s menu specifies that an 18% charge will be added to all bills for parties of 6 or more customers.  The customer’s bill for food and beverages for their party of 8 includes an amount on the tip line equal to 18% of the price for food and beverages and the total includes this amount. ABC distributes this amount to the appropriate employees. The 18% charge is not a tip for tax purposes. The amount included on the tip line is a service charge dictated by ABC. When distributed to employees, the service charge is treated as regular wages.

Employers should remind employees that all cash tips received by an employee are wages for FICA tax purposes and, therefore, must be reported to the employer.  Cash tips specifically include the tips servers receive from customers, tips charged on credit and debit cards, and tips received from other employees under any tip-sharing arrangement.

We recommend that as a hospitality industry employer, you review your gratuity policies as well as your reporting and recordkeeping practices to ensure compliance with the new rule.

Please refer to the following IRS links for additional information: