An updated tax law affecting gratuities that are automatically added to large parties should be carefully considered by restaurant owners. Likewise, servers who previously enjoyed the guaranteed income from those large group “tips” now must wait for payday if the practice continues.
Effective this month, the Internal Revenue Service will begin classifying 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 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 2014.
In a statement, the IRS said it noticed an increase in the use of “auto-gratuities” and that it believed “additional clarification in this area would be in the best interest of tax administration.”
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.
Please contact the Lundell Law Firm if you would like to discuss the effect of this new law on your business.