Automatic “Gratuity” is a “Service Charge” Wage According to IRS

You’re out for a nice dinner on a special occasion, then all of a sudden the waiter shows up with a bill. You scan down to the bottom to notice an “automatic gratuity” of 18-20% or more. The waiter was serviceable, not great, but a mandatory automatic “tip”? If that rubbed you the wrong way, I’m sure you’re not alone.

What once started as a rare “automatic gratuity” for large restaurant groups (“large party fee”) a few years ago quickly spread to just about any size party at many restaurants. Other flavors of the same scheme include “bottle service charges”, “luggage assistance charges”, and “room service fees”. Even pizza or other food delivery businesses were getting in the game as well – charging mandatory “delivery service fees”. A bit of a sham, since according to many food delivery drivers, they sadly never see a penny of the delivery service fee, even after incurring all of the costs associated with food delivery.

automatic gratuity tax treatment

Now, you know I’m a bit of a frugal guy (probably understatement of the year, I realize, but thought it good for a chuckle). And, I RARELY dine out, preferring instead to save money by cooking. However, I do not abuse the tipping scenario as a means to save money. I usually start with a floor of 15% and ceiling of 25% – and the tip ends up somewhere in between, based on service level. I can’t remember the last time that service was so inadequate that I tipped less than 15%.

That being said, I really don’t like the concept of tipping altogether – in fact, hating awkward tipping scenarios is partially what led to me learning how to cut my own hair and I was stressed out for weeks ahead of the inevitable tipping of a kayaking trip tour guide. I would rather just see restaurants and other tipping profession employers simply pay their employees a fair, livable wage and charge more for their services to cover the cost. If you’ve traveled out of country much, you’ll notice many countries don’t allow tipping as a form of built-in compensation to justify lower minimum wages paid to employees (although many Americans still feel cultural tip guilt and keep tipping away).

Suggested tip amounts so that I don’t have to play a guessing game, use my brain for math, or break out a phone calculator? That’s fine and dandy. But the automatic gratuity (an oxymoron) particularly rubbed me and I’m sure many others the wrong way.

Well, thanks to IRS rules on automatic gratuity, that started in 2014, mandatory tipping or similar service charges may one day go extinct.

It’s not that the IRS is outlawing the practice, rather, they are reclassifying automatic gratuities as “service charges“, which are treated as wages, rather than tips for employer tax records, with the following statement,

The Internal Revenue Service reminds employers that so-called “automatic gratuities” and any amount imposed on the customer by the employer are service charges, not tips.

Service charges are generally wages, and they are reported to the employee and the IRS in a manner similar to other wages. On the other hand, special rules apply to both employers and employees for reporting tips. Employers should make sure they know the difference and how they report each to the IRS.

According to the IRS, examples of service charges include:

  • Large dining party automatic gratuity
  • Banquet event fee
  • Cruise trip package fee
  • Hotel room service charge
  • Bottle service charge (nightclubs, restaurants)

With the IRS clarification, the result is that the restaurants would lose a special tax credit that is available to them for paying their share of payroll taxes on tip income (if that income were instead classified as a wage). So many, if not all, employers will stop the auto-tipping practice so that their employees can get tips the old fashion way and then they can keep getting the special tax credit.

Hence, the end of automatic gratuities. It’s a step in the right direction.

Automatic Gratuity Discussion:

  • Do you dislike automatic tipping policies? Are you happy about this change?
  • What’s the most frustrating or highest % automatic gratuity story scenario you’ve encountered?
  • Do you think the U.S. tipping culture should change?

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