Restaurants May Want to Reconsider Automatic Gratuities

It is fairly common for restaurants to have a policy of adding an automatic gratuity of 18% on parties of six or more, or some variation of that idea. That may change in 2014 when the IRS changes the way it treats these charges.

In the past, automatic gratuities were treated as tips and it was up to employees to report the income on their personal returns. Starting in January they will be classified by the IRS as service charges since they aren’t voluntary. Service charges are treated as regular wages and subject to payroll tax withholding which will complicate payroll reporting for restaurants charging automatic gratuities. In addition, instead of servers leaving with their tip money after each shift, they will have to wait until payday to receive money collected from automatic gratuities.

Restaurants are required to report and pay Medicare and Social Security taxes on the amounts employees report receiving as tips, however they may be eligible for an income tax credit for some or all of those payments. Service charges will not be eligible for the income tax credit.

The new classification may cause many restaurants to review their policies regarding automatic gratuities. One suggestion is for restaurants to suggest different tip amounts on the bill. The IRS has said that this practice is not subject to federal withholdings because the decision to leave a tip and the amount is still up to the discretion of the consumer.

If you are in the restaurant business we suggest contacting your payroll provider for information on how this new policy will affect you in 2014. If you have any further questions please contact Hertzbach at 410-363-3200.