Restaurant Tipping in 2014

Restaurant Tipping in 2014Restaurant Tipping in 2014The New Year brings plenty of changes to tax rules, and Jan. 1, 2014 brought the new law regarding restaurant tipping. The rule technically went into effect in 2012, but the IRS delayed enforcement until last Wednesday.

When the calendar turned over to 2014, the rules regarding automatically calculated gratuities changed. Automatic gratuities, typically calculated at 18 percent for large parties (sometimes figured at as few as six patrons) were instituted to help ensure that wait staff was properly compensated. Previously, these gratuities were left to the employee to report as income as with non-automatically calculated tips. Now the IRS classifies automatic tips as service charges and views them as regular wages, subject to payroll withholding tax.

IRS Topic 761 – Withholding and Reporting

IRS Topic 761 states the following:

“Employees who receive cash tips of $20 or more in a calendar month while working for you, are required to report to you the total amount of tips they receive. The employees must give you written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to you but must report these amounts as income on their tax returns and pay taxes, if any.

“Cash tips include tips received directly from customers, tips from other employees under any tip-sharing arrangement, and charged tips (e.g., credit and debit card charges) that you distribute to the employee. Both directly and indirectly tipped employees must report tips received to their employer.

“Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to social security tax, Medicare tax, and federal income tax withholding. Common examples of service charges (sometimes called “auto-gratuities”) in service industries are:

  • Large Party Charge (restaurant)
  • Bottle Service Charge (restaurant and night-club)
  • Room Service Charge (hotel and resort)
  • Contracted Luggage Assistance Charge (hotel and resort), and
  • Mandated Delivery Charge (pizza or other retail deliveries)”

Mandatory Versus Voluntary

The IRS updated its ruling since it viewed automatic tipping as mandatory rather than voluntary, making it a service charge rather than a gratuity. A case in which a restaurant recommends a gratuity would not be subject to federal withholdings.

According to the Wall Street Journal, Darden Restaurants, Inc., stopped automatic tipping at 100 of its restaurants in four cities and began testing a system of calculating all bills with 15, 18, and 20 percent gratuities presented on the bill regardless of party size as a reaction to the tax law change. (As of Dec. 30, 2013, Darden had not posted an updated press release on its site regarding full implementation of this new approach to gratuities.)

The key to reducing your headaches and paperwork regarding this new law is to avoid a mandatory gratuity that is now deemed to be a service charge in the eyes of the IRS. The downside of that approach is that your wait staff may end up getting the short end of the stick by being stiffed or under tipped when serving large parties. The Darden approach of suggesting (and pre-calculating) the gratuity at an assortment of rates may have merit: Your patrons can choose without having to worry about the calculation and tip your staff accordingly and appropriately.