Restaurants often charge an automatic gratuity for large parties, usually adding about 18% to the check of parties of six or more. For tax purposes, this charge has previously been considered a tip, though it is not up to the discretion of the customer. This definition may soon change due to an IRS announcement, which provides interim guidance on Revenue Ruling 2012-18.
Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a substantial doubt as to whether the payment is a tip and indicates that the payment may in fact be a service charge:
- 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 the employer policy; and,
- Generally, the customer has the right to determine who receives the payment.
Most restaurant workers receive an hourly pay from their employer that is below the federal minimum wage of $7.25 per hour (the federal minimum cash wage for servers is $2.13 per hour) and use tips to supplement this income. Many servers do not like the idea of mandatory gratuities being treated as wages because they will be subject to up front withholding and they will not receive that tip money until next pay day, which may be weeks away instead of at the end of the daily shift.
Many national restaurant chains are currently experimenting with dropping the automatic charges for large parties to see what impact the policy has on their servers. The restaurants originally adopted the automatic charges for large parties, in part, to protect their servers from being stiffed on large tabs.
Another downside for employers in classifying these automatic charges as wages is that they do not qualify in calculating the employer tip credit under Section 45B.
For more information on how Revenue Ruling 2012-18 may affect the restaurant industry, please contact Tax Shareholder Jeff Eischeid at email@example.com or (770) 396-2200.