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Automatic Restaurant Tips IRS New Rule Takes Effect

Restaurants are reconsidering automatic gratuities because of a new IRS rule. Beginning in 2014, automatic gratuities charged by restaurants and others in the hospitality industry will be treated as service charges rather than tips.

The IRS developed this new rule in 2012 but delayed the effective date until 2014 to give restaurants time to revise their business practices.

This means that restaurant owners now will have to monitor and keep track of these charges, withhold taxes on them, and report them to the IRS. In the past, reporting of tips has been the primarily responsibility of employees, who report their tip totals to the employer. The employer would then only withhold on and report the tip amounts disclosed by the employee. Now, employers will have to share this burden.

It has been a common practice in the past for restaurants to add an automatic gratuity for serving large parties, typically 18% for parties of six or more. Facing increased paperwork and other compliance burdens, many restaurants are saying they will abandon the practice and may only “suggest” an appropriate tip amount on the check. Waiters and waitresses are unhappy with what they see as a potential reduction in income with the loss of these guaranteed tips.

The paperwork burden is not all that is at stake for restaurant owners. Treating automatic service charges as wages forces owners to include automatic gratuities in the wait staff's hourly wages, which has an impact on employees’ overtime calculation. Also, the servers will have to wait until their paycheck comes in to see this income instead of pocketing the money at the end of their shift, as is the practice with tips. Finally, the employer cannot use these non-tip wages to compute its business tax credit for social security taxes paid on tips.

Review Your Practices

If you are a restaurant owner, you should review your reporting practices and payroll calculations for tips and service charges to make sure you have procedures in place to comply with the new rules. Frazier & Deeter’s tax professionals can help you with this analysis.  

 

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Frazier & Deeter, a Top 100 Largest CPA Firm in the United States, has accountants and business advisors who offer a full range of assurance and advisory services in the areas of audit, tax and management consulting and personal tax planning and compliance. As a leading accounting firm, we serve clients across the nation and internationally that include closely-held companies, SEC companies, and nonprofit entities. Headquartered in Atlanta, Georgia, we have been recognized as the 56th largest accounting firm in the nation, as one of the Top 25 Best Managed CPA firms in the country, and one of the Best Accounting Firms to Work for in the U.S.
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