Tax Implications of Your Tipping Policy

The IRS’ recent ruling on automatic gratuities will bring restaurants and bars under greater scrutiny in reporting their tips.  Increased enforcement efforts are likely to follow.

Another problem is that these tips would be treated as wages, meaning upfront withholding of federal taxes and delayed access to tip earnings until payday.  Since most waiters and waitresses are used to coming home with money in their pockets each workday, this delay could prove a financial hardship for employees.

You may want to consider switching to a system that no longer includes the use of automatic gratuities.  Instead, you may provide suggested tip amounts, add a surcharge, increase food prices or have salaried wait staff not dependent upon tip wages.

Understanding the Rules

A tipping practice that would not be considered an automatic gratuity includes displaying sample tip calculations of 15 percent, 18 percent and 20 percent on customer receipts, but leaving the tip line blank for the customer to fill in.

Another option is to include tips in wages.  Service staff are fully compensated by their salary.  Therefore, gratuities are not accepted.

Other restaurants supplement employee wages by instituting a certain percentage surcharge on each bill.  There are some drawbacks since restaurants prohibiting tips will lose the payroll tax credit they receive for tipped wages.  Furthermore, state laws regulating service charges may create some additional compliance considerations for surcharges used to compensate restaurant staff.


Important Takeaways for Restaurants and Bars

Restaurant and bar owners should take these steps:

(1)  Evaluate whether their current practice would constitute an automatic gratuity;

(2)  be sure to treat automatic gratuities as service charges or non-tip wages for purposes of calculating regular rate of pay, overtime wages and tax liability;

(3)  be clear that any tip calculations provided on a bill are merely suggestions and discretion still lies with the customer as to how much to tip and who receives the tip;

(4)  determine whether any state laws apply to service charges; and

(5)  clearly notify customers if tipping is no longer required.