The IRS Plans to Examine Proper Reporting of Tips and Service Charges
The Internal Revenue Service (IRS) has announced it will start enforcing and focusing on the practices of restaurants beginning January 2014 regarding the tax-ability of tips and service charges.
According to federal regulations, a cash tip has always been defined as any additional gratuity paid to an employee outside of their regular wages, and should be included as taxable income. Cash tips include, but are not limited to:
· Tips given directly to the employee by a customer
· Tips given directly to the employee from another employee (including tip-sharing situations)
· Employee tips added to a credit card charge as part of a customer’s bill
Conversely, automatic gratuities – such as a percentage that an employer adds to a customer’s bill for a large party – and then pays to the employee, are considered a service charge. A service charge is treated as any other taxable wage, and should be properly characterized as wages. Per IRS regulations, the absence of any of the following indicates that the payment may be a service charge and not a tip:
1. The payment must be made free from compulsion.
2. The customer must have the unrestricted right to determine the amount.
3. The payment should not be the subject of negotiation or dictated by employer policy.
4. Generally, the customer has the right to determine who receives the payment.
Since service charges are not considered employee tips, restaurants cannot include service charges in their FICA tip credit calculation. In addition, employers who share portions of automatic gratuities must recalculate their employees’ hours and even overtime rates, since automatic service charges are considered wages for the employees and their gross income.
In addition, automatic service charges and gratuities are subject to Wisconsin Sales Tax.
Please contact our office to ensure your policies provide proper treatment of tips versus service charges and that you are in full compliance. Additional details can be found on the IRS website at: https://www.irs.gov/irb/2012-26_IRB/ar07.html.
The bottom line: Hire or consult with a professional accountant that can help you understand how this change impacts your business. For more information, contact EWH Small Business Accounting at
262-796-1040 or visit www.ewhsba.com.