Restaurants utilize various services to accommodate their customers, including wait and bar staff, counter personnel (i.e., maitre d’s), and valet. These services not only benefit the restaurant and its customers, but also benefit the employees. Restaurants must be careful, however, when using these services because the Internal Revenue Service (“IRS”) recently issued guidelines on service charges and tips that plan stricter compliance with results that primarily govern restaurant industry gratuities.
The absence of any one of these factors indicates that the payment is a service charge and not a tip. For example, a mandatory service charge for valet service or a mandatory gratuity automatically added to a customer’s food bill for a large party, are considered ordinary wage payments rather than tips. In contrast, a customer’s own decision to give a gratuity to a waiter, valet driver, or a bartender would be considered a tip. Or if a restaurant includes suggested amounts for different tips on a bill but leaves the tip line blank, the payment is a tip because the customer ultimately can decide the amount.
Importantly, service charges are required to be reported as wages, and all applicable payroll tax withholding is required. Distributed service charges may be used to help employers meet their obligation to pay employees the minimum wage. However, a compulsory service charge cannot be counted as a tip credit. Under the Department of Labor (“DOL”) regulations, 29 C.F.R. § 531.55, as amended effective May 5, 2011, restaurants that automatically add a gratuity (deemed by the DOL to be a service charge and not a tip), cannot take a tip credit for the mandatory gratuity the establishment receives, even if management passes the gratuity on as a tip to employees. Instead, the mandatory-gratuity receipts would be considered part of the employer’s receipts.
Increased identification of service charges can affect tip outs, too. Tip outs occur when directly-tipped employees distribute a portion of their tips to indirectly-tipped employees, including bartenders. If a tip out is appropriate for a service charge, employers should remember that a service charge retains its identity as wages throughout the tip out and it should be reported as wages.
Restaurants should ensure compliance with the new IRS guidelines when classifying gratuities as tips or service charges. Employees are required to keep daily records of the tips they receive, and report those tips to their employer. Since all tip income is taxable, unreported tips can cause big problems for employers. Because of this potential liability, employers should remind tipped employees of their obligation to report all tips they retain, including cash as well as charged tips. Employers should also remind their employees that the obligation to report tip income applies to any person who receives $20 or more in tips in a month, whether they are directly-tipped employees or indirectly-tipped employees.