The Internal Revenue Service is cracking down to make sure restaurants comply with a 2012 rule change governing how servers’ gratuities are treated. The change may force restaurants to reconsider their policies on so-called “automatic gratuities.” In an official IRS posting about the tax rules on reporting and withholding tips, the federal agency explains:
“Employees who receive cash tips of $20 or more in a calendar month while working for you, are required to report to you the total amount of tips they receive. The employees must give you written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to you but must report these amounts as income on their tax returns and pay taxes, if any.”
But that’s not even the part that has restaurateurs perplexed and concerned.
The rule addresses how automatic gratuities are treated for tax purposes. Rather than simply divvying up these tips at the end of the night, all automatic gratuity tips will now be classified as service charges. So they will be taxed as regular wages and subject to payroll tax withholding. According to the IRS, “These non-tip wages are subject to social security tax, Medicare tax, and federal income tax withholding. In addition, the employer cannot use these non-tip wages when computing the credit available to employers under section 45B of the Internal Revenue Code.”
What is the IRS Rule on Automatic Gratuities?
If you’ve ever dined with a large party, you’re familiar with how restaurants add a set amount on to the bill for the tip (typically 18% for parties of 6 or more). It’s a common way to cut down on the work involved in calculating tips in a large party and helps ensure servers get gratuities in other situations. Under the rule, restaurant owners and hospitality providers have two choices:
- Add automatic gratuities to your wait staff’s wages.
- Stop charging customers for automatic gratuities, if you want to avoid income tax complexities.
The IRS rule on automatic gratuities covers the following:
- Large Party Charge (restaurant).
- Bottle Service Charge (restaurant and night-club).
- Room Service Charge (hotel and resort).
- Contracted Luggage Assistance Charge (hotel and resort).
- Mandated Delivery Charge (pizza or other retail deliveries).
Restaurant operators are concerned about the paperwork this rule will add to what they’re already juggling.
New IRS Tips Rule Finally Coming Into Play
The IRS automatic gratuities rule was originally announced in 2012. Restaurant owners and hospitality companies were given until this year to figure out how to comply.
Now, two years after it was first announced, the new rule is in force and concerns have intensified. A representative of the National Restaurant Association, Christin Fernandez, told us here at Small Business Trends:
“While the IRS action regarding service charges does not change the law or initiate new policy, the ruling implies enhanced IRS enforcement. We expect some restaurateurs may, as a result, re-examine how they handle automatic gratuities in light of the rule going into effect January 1, 2014. For others, it may simply be business as usual (again, this is not a new policy and the ability for restaurateurs to determine auto-gratuity practices in their individual establishments has not changed in any way).”
Fernandez said that regardless of how individual restaurateurs respond to the IRS rule, it’s critical that operators maintain the flexibility to implement policies that make the most sense for their individual business, workforce and customers.
Gratuity Photo via Shutterstock