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How IRS Rule Change on Automatic Tips Could Impact Restaurants

February 05, 2014

Many banquet facilities and large special event providers are already following these new rules.

This new IRS rule does change things on the Federal tax side. The interesting thing is that the State of RI has always deemed those automatic tips as service charges for sales and meals tax purposes. Many banquet facilities and large special event providers already treat those gratuities as revenue and pay out all or a portion of them to the employees, particularly in the case where the employees are already making at least minimum wage. Some businesses withhold a certain amount of the tips to cover costs related to handling them. For instance, if the costs are charged on a credit card, the business incurs that cost. So, it’s not unreasonable that you withhold 2% or 3% to cover those costs.

To some extent, this new rule will make the cash flows easier to manage. With so little cash used by customers these days, it becomes a problem to pay out tips at the end of the day. Also, for employees getting less than minimum wage (i.e. – wait staff getting $2.89/hour), on occasion there isn’t enough in the net check to pay the employee’s full share of the social security and Medicare taxes owed on the declared tips received in cash. The employer could get stuck paying the bill.

Many restaurants have already taken the step to pay the credit card tips out with payroll. The only change to this new rule is how to record things. Before this rule credit card tips received would likely be recorded as a credit to a payable account to employees and then when paid through payroll, that account would be debited to relieve the payable. Now, instead of crediting a payable, the credit would be to service charge revenue. Instead of debiting the payable, a payroll expense account would be debited. Net result should still be zero, assuming the employee would have voluntarily reported those tips under the old method. The assertion that this will cause employers to pay more in payroll taxes is true, if employees weren’t reporting all of their income previously. However, for those employers who properly tracked employee tip reporting and strongly encouraged compliance, there shouldn’t be a major change in payroll tax expense.

This new rule will certainly force better compliance with income reporting for the employees and I suspect that part of the impetus for the new law was to take as much responsibility away from the employee to voluntarily report earnings.

How much will this impact your restaurant or banquet facility? Do you often put an automatic gratuity on bills for large parties? I have heard groups discussing changing the “mandatory” language to “suggested” and have the receipt provide ranges, such as 15% is x, 18% is x and 20% is x. That would get around the new rule, since it would be the customer’s choice on how much to tip.

How does your group handle these changes? If you have questions or would like more information on this IRS rule change, please contact me or any member of our Hospitality Services Group at

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