The IRS Rules On When A Tip Not A Tip

Contributed by Christopher L. Voltz

 

Enforcement of a new IRS ruling is coming soon.  More than a year ago, the IRS issued a ruling stating that an automatic gratuity charges must be treated as a service charge and not as a tip. The IRS Ruling goes into effect on January 1, 2014. In its ruling, the IRS stated that to qualify as a tip, the payment must meet four requirements:

 

  • The payment must be made free from compulsion
  • The customer must have the unrestricted right to determine the amount
  •  The payment should not be the subject of negotiation or dictated by employer policy
  • The customer has the right to determine who receives the payment.

Here are two common examples:

Example A: When a menu specifies that an 18% charge will be added to all bills for parties of 6 or more customers and a customer’s bill for food and beverages for her party of 8 includes an amount on the “tip line” equal to 18% of the price for food and beverages, the 18% charge is a service charge and not a tip because the customer did not have an unrestricted right to determine the amount of payment.

Example B: When a restaurant includes sample calculations of tip amounts beneath the signature line on its charge receipts for food and beverages provided to customers and actual tip line is left blank, the amount the customer inserts on the tip line qualifies as a tip because the customer enters the amount of the tip without compulsion.

This is important for restaurant owners because service charges are treated as normal wages and are subject to the normal withholding and reporting rules.  While tips are also treated as wages, the burden is on the employee to report her/his tips to the employer.  Restaurant owners should also be aware that service charges cannot be included in FICA Tax Credit calculations.

There are many implications associated with the IRS’s Ruling and restaurant owners should review their tipping and payroll policies with qualified counsel before the end of the year.