A new ruling that took effect 1/1/2014 now classifies automatic gratuities as service charges that should be treated as wages and cycled through payroll systems before they are paid out to servers. They must now also be factored into hourly wage rates.
Starting January 1, 2014, “automatic gratuities”—often used to prevent servers from being undertipped when handling large parties—will be treated as wages and not tips, advises the Tax Foundation, a nonpartisan tax research group based in Washington, D.C.
Under Rev. Ruling 2012-18 from the Internal Revenue Service (IRS), a sharper distinction is now drawn between tips and service charges, the Tax Foundation reports. Both are taxable, but tips are reported and cashed out that day.
Under the new rules, the Tax Foundation says, these criteria must be in place to qualify any compensation as a tip:
- the payment must be made free from compulsion;
- the customer must have the unrestricted right to determine the amount;
- the payment should not be the subject of negotiation or dictated by employer policy; and
- generally, the customer has the right to determine who receives the payment.
Automatic gratuities don’t meet these criteria, so they will now be classified as service charges, the Tax Foundation says—and employers will have to cycle these charges through their payroll system to distribute to servers, delaying payment by up to two weeks. The charges will also have to be factored into hourly wage rates.
The likely result of the change, the Tax Foundation says, is that hospitality outlets will discontinue automatic gratuities for large parties, to avoid additional compliance costs and to allow employees to take their tips home on the day they get them. Getting servers to work large parties will probably be harder, the group notes.
The IRS views this change as the latest step in its effort to crack down on underreported tip income, the Tax Foundation says, even though this evasion has been curtailed by previous enforcement efforts targeting employee and employer reporting requirements, as well as by high-profile investigations targeting violations. A major shift from cash to credit as a primary method of payment has also stemmed violations, it’s noted.
To the IRS, the latest clarification is being made “in the best interests of the taxpayer” the Tax Foundation notes—but it is also a change, the group feels, that will make life a little bit harder for hospitality organizations and their staffs.
For more information, go to www.taxfoundation.org