A New IRS Ruling Regarding Automatic Gratuities Takes Effect 1/1/13

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The IRS issued a ruling last year that went into effect January 1st regarding taxes paid on automatic gratuities added to the bill of large parties.  The ruling states that these gratuities are not tips for the server, but revenue for the restaurant.  Theis means that this amount must be taxed as revenue for the restaurant.  Sales tax must be paid on these gratuities.  The amount turned over to the server is a wage, not a tip.  Payroll taxes must be taken out before the money is paid to the server.  Most importantly, since there is no tip involved in the transaction the server must be paid at least the full minimum wage instead of the “server wage” in your state.

The response of most restaurants has been to simply ban the practice of adding gratuities to the checks of large parties.  In fact many restaurant have simply told their staff that the IRS banned automatic gratuities.  This is an oversimplification of the issue that is inaccurate.  In reality what the IRS did was rule that automatic gratuities should be treated as service charges instead of tips.  This brings up a bigger issue: Has your restaurant been following the rules on service charges?

I have written several posts warning restaurant owners of seven-figure settlements servers around the country have been winning against restaurants who have not been following the law on service charges.  All of the rulings that apply to automatic gratuities have always applied to service charges.  More importantly if the restaurant gives any portion of that service charge to a banquet manager, banquet captain, or retains it as restaurant revenue they are violating even more laws.  If you have been in violation of these laws, this is a very good time to fix this.  Choosing to obey the new ruling that hurts servers, while ignoring the laws in their favor, will not play well with a jury.

Yesterday my traffic exploded on the Tips Squared site.  Almost all of it went to my post on the new law regarding automatic gratuities.  The second most popular post was about illegal practices regarding service charges.  The third most popular was my post warning restaurant owners about lawsuits won by servers against major chains regarding very common restaurant practices.  I am sure some of the readers were managers trying to stay within the parameters of the law.  Some of them were servers though.  Were they members of your staff?  It might be a good time to make sure that you are in compliance with all laws on this issue.