Alert: The Use of Automatic Gratuities and IRS Rules Effective January 1, 2014

Tuesday, January 21, 2014

Beginning January 1, 2014, all automatic gratuities must be recorded for tax purposes as "service charges". A tip is not a tip if it is mandatory; rather, it is a service charge, which represents reportable income to the restaurant operator.

Automatic gratuities paid to servers must be classed as "non-tipped wages", which do not qualify for the FICA tip credit. Operators are required to pay state sales taxes on all automatic gratuities (which are considered "service charges").

To comply with the new IRS rules, a restaurant will have to take a hard look at its point-of-sale system and payroll practices. And now, some national restaurant operators have decided to stop charging customers automatic gratuities. Instead, they are moving to "suggested or recommended" tip amounts printed on customer checks.

Restaurant operators will have to make a choice: Risk alienating their servers, or change the way automatic gratuities are collected, taxed, recorded, and paid out. It may be time to move from required to recommended tip amounts.