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Mandatory Tip? New Tax Treatment

On Behalf of | Sep 6, 2013 | IRS |

In 2012, the IRS issued Revenue Ruling 2012-18 directing that automatic gratuities-tips added by the restaurant to the bill of large parties– be classified as service charges, which are treated as regular wages subject to payroll tax withholding, rather than tips to be reported by the employee. The IRS later delayed implementation of the rule until January 1, 2014 to allow restaurants time to implement strategies for complying with the new rule.

The IRS regards automatic tips as service charges because they are not payments made voluntarily by the customer. However, providing a list of suggested tip amounts would not be considered a service charge because the customer is free to choose whether to tip and how much to tip. Restaurants that continue the practice of adding a gratuity to the bills of large parties will be required to factor those tips into employee pay. This will confuse payroll accounting because hourly rates of employees may change day to day based on the number of large parties served each day. Because of this complicated accounting, it is likely that most restaurants will do away with the automatic gratuity.

Revenue Ruling 2012-18 discussing the rule can be found here http://www.irs.gov/irb/2012-26_IRB/ar07.html and Revenue Ruling 2012-50 extending the time for implementation of the rule can be found here http://www.irs.gov/pub/irs-drop/A-12-50.pdf.


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