An updated tax rule is causing restaurants to rethink the practice of adding automatic tips to the tabs of large parties.
Starting in January, the Internal Revenue Service will begin classifying those automatic gratuities as service charges-which it treats as regular wages, subject to payroll tax withholding-instead of tips, which restaurants leave up to the employees to report as income.
The change would mean more paperwork and added costs for the restaurants-and a potential financial hit for waiters and waitresses who live on their tips but don't always report them fully.
As stated in a recent Wall Street Journal article, Darden Restaurants, Inc. owner of Olive Garden, LongHorn Steakhouse and Red Lobster, has long included automatic 18 percent tips on the bill for parties of eight or more at its more than 2,100 restaurants, but is experimenting with eliminating them because of the IRS ruling, said a spokesman.
The change will complicate payroll accounting for restaurants that stick with automatic tips, because they will need to factor those tips into pay, meaning hourly pay rates-could vary day to day depending on how many large parties are served.
The change comes amid increasing costs and record-keeping requirements for restaurants. In January, restaurants with 50 or more full-time workers will be required to offer health coverage to employees working 30 or more hours a week, though penalties don't begin until 2015.
Restaurants adopted automatic gratuities to help ensure that their servers-whose tips supplement a salary that is often less than the federal minimum wage of $7.25 an hour-weren't stiffed on large tabs. But many servers are likely to support dropping the practice because they don't like the idea of their tips being treated as wages, which requires upfront withholding of federal taxes, and means they won't see that tip money until payday.
The IRS ruling was issued in 2012 to clarify and update earlier tax guidance on tips, which didn't spell out how automatic tips were to be treated. Restaurants persuaded the agency to delay implementation until next year.
The updated rule says the automatic tips are service charges because they aren't voluntary. In a question-and-answer section of the ruling, the IRS provided an example of a restaurant suggesting different tip amounts, and said that practice isn't subject to federal withholdings because the customer is still free to choose whether and how much to tip.