IRS Tax Tips: Crackdown on Automatic Gratuities

The next time you eat at a restaurant as a member of a large party don’t assume the tip is factored into your final bill. At the beginning of January, a key change in a federal income tax code closed a long-standing tax loophole when it comes to tipping for large groups.

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In an attempt to cut down on unreported income, as of January 1st, the IRS began requiring that those automatic gratuities typically added onto restaurant bills of large parties to help guarantee the server a fair gratuity must now be treated as wages, not tips. IRS Rev. Ruling 2012-18 makes a clear distinction between tips and service charges. According to the new law, to be considered a tip, the compensation must:

  • Be made freely without being compulsory

  • Give the customer the right to determine the amount to be provided

  • Not be dictated by restaurant policy

  • Give the customer the right to give the payment to whomever he or she chooses

Typically comprising 15 to 18 percent of a bill for large parties, automatic gratuities tacked onto restaurant bills don’t meet the above criteria. Instead, they are considered service charges. This means they must be included in paychecks, a requirement that makes it much more likely that restaurants will eliminate these automatic gratuities.

Bad News For Waiters And Waitresses

Eliminating automatic gratuities is not good news for wait staff, who sometimes find that large parties don’t always tip enough to compensate for all of the work they do running around serving many people. When it comes time to pay the bill, and an automatic gratuity isn’t built in, waiters and waitresses are often the ones shortchanged—sometimes unintentionally and sometimes intentionally.

This new requirement of having to include automatic gratuities on the paychecks of waiters and waitresses makes accounting more complicated. Many restaurants are choosing to discontinue this practice. Including automatic gratuities in paychecks also means that the wait person isn’t able to take home tips that same day.

The fact is that food servers and bartenders are already required to report all tips to the Internal Revenue Service as income and pay the required taxes. The shift by many customers from cash to credit for payment has meant that nowadays most tips are accounted for and taxed. Not surprisingly, cash tips aren’t always reported, but it’s not a wonder considering that waiters and waitresses average a mere $5 per hour base salary, with some states paying even less. The low base salary means that waiters and waitresses rely heavily on tips for income.

Likely Results

Instead of including automatic gratuities for large parties, it’s more likely that many restaurants will discontinue the practice, which means tipping wait staff sufficiently will be up to customers. Given the fact that being tipped adequately can sometimes be a gamble with large groups, some servers will choose not to serve large parties, if they have that option.

So the next time you go out for a meal with a large group of people, be fair to the wait staff. When you find that no automatic gratuity has been added, make sure to tip 20 percent as a thank you for a job well done.

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