|Autograts vs. Service Charges|
Restaurants that currently charge an automatic percent service charge for large parties (ie 18%) will no longer be able to treat these amounts as tips in 2014, according to a recent IRS ruling. The IRS clarified that service charges paid on or after Jan. 1, 2014, will be considered part of employee wages and subject to withholding and reporting requirements.
As a result of this change in classification, employers will not only lose the benefit of having these amounts included in their FICA tip credit calculation, but such payments will be part of the tipped employees’ hourly wages. The ruling also determined that to the extent any portion of a "service charge” is distributed to an employee, it is wages for FICA tax purposes.
When is a tip a tip?
The ruling provides that a tip satisfies the following four factors:
1. The payment must be made free from compulsion.
When is a tip really a service charge?
The ruling provides the following illustration of an alleged tip that is actually a service charge: A restaurant’s policy of adding an 18 percent service charge to the bill for parties of six or more is a service charge rather than a tip because the customer did not have the unrestricted right to determine the amount of the payment – it was dictated by the restaurant’s policy – and the customer did not make the payment free from compulsion.
Can I put a suggested tip amount on the receipt?
A bill with sample calculations of different tip amounts, where the actual tip line and total amount line is left blank, is truly a tip.
How do you ensure a tip is really a tip?
To ensure a tip is not actually a service charge according the IRS, make sure the tip line and total amount on any bill is left blank for the customer to complete in his or her discretion. While a restaurant may include sample calculations on the bill of different tip amounts (e.g., 15% = X), these must be clearly identified for reference purposes only so the IRS does not determine a certain amount is being mandated from the customer.
Do not print menus that say an automatic gratuity will be added to the bill.
What about auto-gratuities for banquets?
Although a service charge on a restaurant bill will most frequently be encountered, restaurants should be cautioned that auto-gratuities paid for catering, banquets, weddings and other amounts mandated by employer policy will be covered as well.
Do I have to pay sales tax on the service charge?
Mandatory service charges are part of the cost of the food and therefore subject to sales tax. Tips, which are discretionary, are not part of the cost and therefore not subject to sales tax.
What difference does it make whether a payment is a tip versus a service charge?
What if I make a mistake?
Taxpayers are required to account for service charges separately from tips. Business systems, whether manual or automated, need to be configured in such a way that these amounts can be accounted for in the normal course of business.
If the IRS audits your business and finds that amounts have been misclassified as tips, they will propose adjustments to Form 941 which in turn may require a change to the employer credits for FICA taxes paid reported on Form 8846. Any mistakes will result in the imposition of penalties and interest.
Businesses should ensure that they are complying with these rules. The fact that the IRS has recently issued a ruling in this area indicates that increased scrutiny from the IRS may be coming in the near future.