Required Gratuities to be treated as Non-Wage Tips
As of January 1, 2014, the IRS will treat mandatory service charges — such as those frequently added to restaurant tabs for large groups — as “service charges” rather than “tips.” As a result, employers charging automatic gratuities will want to review their existing policies to make sure they comply with the new rule.
Common practice at many restaurants is to require large groups of customers to pay a percentage gratuity (“auto-gratuity”) on top of the regular bill. Typically, the restaurants then pass on some or all of these auto-gratuities to the waitstaff. For the employees, these automatic “tips” count as wage income. For the employer, they create withholding obligations and FICA liability.
However, under the IRS rule currently in place, neither the employer’s withholding obligations nor its FICA liability arises before the employee reports the tip income to the employer by the 10th day of the following month.
Under the rule scheduled to go into effect on January 1, the IRS will no longer characterize these auto-gratuities as “tips,” but will begin treating them as “service charges.” One consequence: The employer’s withholding and FICA responsibilities will arise at the time the auto-gratuity is paid, rather than later, when the employee reports the tip income to the employer.
Additionally, implementation of the rule will limit an important income-tax credit for those in the food and beverage industries. Under the tax law, sellers of food and beverages may claim a credit for any FICA taxes they pay on the difference between “tips” and the minimum wage as it existed on January 1, 2007. Under the new IRS rule, auto-gratuities will no longer count as “tips” and therefore will no longer count toward figuring the tax credit.
Implementation of the new rule has already been postponed once. The IRS originally announced that it would begin implementing the rule in 2013, but then later delayed its implementation to 2014.
The IRS provides an example that suggests an alternative for restaurants to consider. In the example, the restaurant prints some sample tip calculations on its receipt, but then lets the customer decide whether to enter any amount on the tip line or to leave it blank. The IRS states that because the customer in this situation has complete discretion as to what to add to the bill, any amount left on the tip line would qualify as a “tip.”
Implementation of the rule might also affect other automatic charges, including those for bottle service (restaurants and nightclubs), room service (hotels and resorts), luggage assistance (hotels and airports), and delivery (e.g., mandated pizza and retail delivery).
If you have questions about how the new rule might apply to your business, let us know.