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:

• The payment must be free from compulsion.
• The customer must be able to determine the amount of the payment without restriction.
• The payment cannot be negotiable or dictated by the employer.
• The customer should generally have the right to decide who receives the payment.

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.

Having lived in Nevada for the majority of my adulthood, I have long been acquainted with tipping. It has gotten to the point where I feel guilty for not putting a dollar in the tip jar at Starbucks for a $2 coffee or at my local sandwich shop. While living in Las Vegas I heard stories of people making thousands of dollars a night as a cocktail waitress or doorman at a club and valet drivers earning six figures a year.

Since these tips were usually in the form of cash, I presumed that a lot of income wasn’t being reported to the IRS. I knew that the casino industry had agreements in place with the IRS for years where a fixed amount of tips per hour was reported on their W2s. I’m sure more tip income was earned, but since cash tips are so hard to trace the IRS needed some piece of the pie without being overly burdened.

Recently, my presumption on tip earners not claiming all their tips has come true. According to a Las Vegas Review Journal article, a club co owner and some of his employees recently got busted for not claiming all their tips as income. This particular club owner didn’t pay $141,306 in taxes on $403,732 of tip income in just two years! Three hosts and a doorman plead also plead guilty, although the article doesn’t say what they earned. These employees didn’t have any sort of elaborate scheme; they just didn’t report hundreds of thousands of dollars to the IRS from their tips!

I don’t know this guy personally, but I’m sure he wasn’t living a modest lifestyle and driving around town in a Hyundai. The IRS can easily construct a taxpayer’s income. If someone is driving around in a Porsche, living in a mansion with gardeners and pool guys, and wearing fancy jewelry, the IRS can figure out how much all that costs and calculate how much income would be needed to facilitate this lifestyle. Not being truthful to the IRS is an easy way to land in jail. Just ask Al Capone who got busted for tax evasion!