Gratuity and Taxes

This month, as 2014 comes to a close,  we are taking a look back at some of the most important blog topics we have covered both in case you missed them, and to help you prepare for 2015!

“A Gratuity of 18% Will Be Charged for Parties Over 6”

According to IRS Ruling 2012-18, a tip is defined as “(1) payment must be made free from 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; and (4) generally, the customer has the right to determine who receives the payment.

tips in a jar

The absence of any of these factors indicates that the payment is a service charge and not a “tip”. These service charges are considered restaurant income; if they are given to the employees, they are then considered wages and not tips.

As they are not tips, but rather wages, restaurants may not count the service charges (automatic %’s) toward the FLSA tip credit, even if they distribute the gratuities to the employees. When employees are serving parties not subject to an automatic service charge along with parties that are subject to an automatic service charge at the same time, it becomes a daunting task to determine what wages to pay the servers as they are performing both tipped and non-tipped duties, and only the tipped duties are eligible for the FLSA tip credit.

If the service charges are distributed to the employees, they become wages and therefore increase an employee’s regular rate of pay and must be factored into any overtime calculations. As if that’s not a big enough headache, restaurants must also remember to report service charges as employee’s wages not as tips on their payroll reports. They should also take these into consideration when completing their Employer’s Annual Information of Tip Income and Allocated Tips form. For income tax purposes, the service charge distributed to employees as wages should be reported as wages on the business tax return.

As you can imagine, this ruling has created a large amount of class actions alleging the improper failure to include service charges, aka mandatory gratuities, into the calculation of employee’s regular rate of pay. The easiest way for restaurants to avoid the above headaches and legal action is to simply eliminate the automatic gratuities, but provide suggested tip amounts.

HR Strategies provides their clients with guidance and assistance with these and other tricky HR matters. To learn more, contact us via the web by clicking here or give us a call today at:



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About HR Strategies

HR Strategies is a private human resource management firm created to enable small business owners to focus on their core competencies, rather than the tedium of running payroll, providing employee benefits, or the many other facets of human resource administration. We allow business owners to concentrate on their passion, without being distracted by countless human resource responsibilities.

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