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2014 – Tips vs. Service Charges – The Rules Have Changed

Large party automatic gratuities may be a thing of the past. These were originally implemented to ensure servers were being adequately compensated. However, as of January 1st, the IRS now considers these automatically calculated tips as service fees, and will treat them as regular wages, subject to payroll withholding tax.

Think back to your last experience at a restaurant when you were with a large group of people and your tip was calculated into the bill when you went to pay it. You probably knew beforehand that this would be the case since it was most likely printed somewhere that a certain percent gratuity would be added to the bill for tables with more than a certain number of people. Did you consider this a tip or a service charge?

The IRS uses the following factors to determine whether a payment is a tip or a service charge:

If even one of these conditions is not met, the payment is considered a service fee and not a tip.

This is a big change for employers and employees. The employer now has to treat this money as income and has to include it in that employee’s regular wages. This means it is subject to normal reporting and withholding requirements. Also, employees will not be able to take their money as they receive it, they will have to wait until the next pay day.

This ruling will probably deter a lot of restaurants from including an automatic tip into their customer’s bills. By removing this, it will likely reduce the amount of tips servers will receive. A good way for employers to help their servers get adequate tips is to include suggested tip amounts on the bills. Putting a suggested tip amount on the bill does not qualify the money as a service charge because the customer still has a choice in the decision.






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