November 28, 2014

IRS Now Enforcing Rule On How Restaurants Handle Automatic Gratuities

new irs gratuity rule

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

8 Comments ▼

Susan Payton - Awards Communication Mgr.


Susan Payton Susan Payton is the Communications Manager for the Small Business Trends Awards programs. She is the President of Egg Marketing & Communications, an Internet marketing firm specializing in content marketing, social media management and press releases. She is also the Founder of How to Create a Press Release, a free resource for business owners who want to generate their own PR.

8 Reactions

  1. This rule is a ridiculous one.

    More paperwork is not needed by servers and/or food-service businesses.

    A gratuity is a gratuity.

    Servers look at them as tips.

    Same thing.

    Who thought of this? I know; someone who has never been in the food business!

    The Franchise King®

    • I know, Joel. I’ll be interested to see how well they can enforce this. Cash is so easy to slip into that pocket…

    • With so much discussion about raising the minimum wage, living wages, etc. this seems counterproductive since most service industry employees receiving gratuities are in lower income brackets. Seems like an unnecessary burden to the business as well. #facepalm

  2. Wow wee! Thanks Robert it is a burden. If people understood why and how to tip this auto grats wouldn’t be necessary. For you people, to keep food costs down I am paid $2.25 per hour. My tips should make up the remaining $5.25 and hour “minimum wage”. But certain groups have no idea how to be civil even if they are making great money like African Americans (10% or less), Internationals (0 to 5%), Arabic (50 cents to $1.00). I got $3.75 or a $90.00 tab last night working for 4 Arabic men for 1 hour!

  3. I am a server at Bar Louie, a restaurant and bar run by corporate authority. From what I understand of this law, restaurants still have the right to add automatic gratuity if they undergo the proper procedures and do the correct paperwork. However, it seems that our corporate feels this is too much work and not worth dealing with, since they have taken away even our ability to add gratuity to tickets on our computer systems. Tonight, I watched a fellow server work her tail off taking care of a large party of about 30 people. This group was particularly rude and demanding. They were, in my opinion, acting with absolutely zero respect or class. These are the kind of people servers already expect a low tip from, if they tip at all. It is usually worth it having to deal with that kind of treatment from those type of people when you at least know you’ll be paid for your hard work due to gratuity. But thanks to Bar Louie corporate and the inability to grat that party, this poor girl received a a total $2 tip on a $400 tab. She wasted 4 hours of her life on these people who did not even have the courtesy to tip her. Along with tip-out for the bartender and bussers, she in theory would have paid the restaurant for her to serve that party. She left work in tears. As much as I love my job, it is sad to me that our corporate cares so little about their servers.

  4. My mother worked as a waitress most of her adult working life. She explained to me that a “gratuity” was meant to show you are grateful. Some of today’s server don’t exhibit that at all instead they are too busy texting or answering someone one on their phone, your glass sits empty while they clean tables or do other chores that they should take care of after serving their customers. I always tip………..according to the service I receive. Auto tipping sometimes makes that go down.

  5. Same thing happened to a co-worker. A ten top left a $10 tip. The waitstaff still has to tip out on their sales to the busser and the bartender. Our busser walked with more than the waitstaff.

  6. Hi all!

    At the end of the day, it is what it is. There is no way that Big Brother will change their course of action. So, we built something to start to make this process a lot easier.

    I’m Greg, the founder of Tip Network. We make it easy for restaurants, bars, nightclubs to easily track, manage, report, and distribute tips to staff and in between staff. You can use Tip Network from any browser and you do not need to integrate us with your Point of Sale. We can support over 1,000,000,000+ ways to track tipping.

    The way it works is really simple. You setup your store one time (adding employees, adding your tip out rules, and adding your banking details).

    Then on a day to day basis you (1) Setup Your Shift – Drag and drop which employees work in what role for that shift, (2) Checkout Employees- The manager can checkout an employee or the employee can checkout themselves (they always both need their 4-digit PIN number), and (3) Close Your Shift – Enter hours for those who part of a pool (we support hourly, evenly, weighted pools).

    We are in private beta right now but we are always accepting new customers. Feel free to reach out to be directly greg@thetipnetwork.com if you’d like to see a demo. Or, you can checkout some product screenshots here: https://www.dropbox.com/s/bc2u6w4tjmgvxk8/Tip%20Network_Product%20Screenshots_Summer%202014_greg%40thetipnetwork.com.pdf

    We started Tip Network because we were bussers/servers/managers/operator ourselves. We think we are on to something and would love to share what we’ve built with you.

    Cheers!

    – Greg

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