Written by: Heather Graham, CPA, CVA

It may surprise many of you that if your bill at the restaurant includes an automatic gratuity of 18% that the automatic gratuity is no longer considered a tip by the IRS and has many different tax consequences for the business and the employee providing the service.  These automatic gratuities are now classified as a service charge.

In order for a payment to be considered a tip the following factors need to be addressed:

  1. The payment is made free of compulsion
  2. The customer must have the unrestricted right to determine the amount
  3. The payment should not be the subject of negotiation or dictated by employer policy
  4. And generally, the customer has the right to determine who receives the payment.

The “Service Charges” are considered regular “wages”, not tips.  These wages are not eligible for the tip credit and must be reported differently on payroll tax returns and W-2s.

Starting in 2013, the penalties that can be imposed by the IRS for not reporting these “service charges” correctly are quite severe.

Call us today if you have any questions!