Franchising News

New IRS Rule Affects Tipping And Gratuities At Restaurants

Written by Tim Morral
Published: 1/30/2014

With many small restaurants already considering changes to their tipping policies, a new IRS rule will make it more difficult for restaurateurs to apply automatic gratuities.

Tips are a time-honored tradition in the restaurant business. Although not all customers are happy with the 18-20% tipping model, many restaurant workers rely on tips for the majority of their income.

New Rules Regarding Tips and Taxes

To make sure their workers receive a fair gratuity, it's common for restaurants to apply an automatic gratuity for parties of six or more. But according to a report in Nation's Restaurant News, a new ruling by the IRS is causing restaurant owners to think twice about automatic gratuity models.

Slated to take effect this month, the new rule defines gratuities that are added to the bill as service charges rather than tips and requires employers to treat them as FICA wages. By reclassifying automatic tips as wages, restaurant employers will be forced to navigate a more complex range of issues (including the manner in which they handle automatic and manual reporting systems) or face penalties from the IRS and possible lawsuits by employees.

One of the concerns is that the new IRS rule will distort calculations for overtime pay, which is based on an average of employees' hourly wages. If an employee has several large parties with automatic gratuities during a busy shift, it could seriously distort overtime wage calculations.

Another issue is the FICA tip credit rule that allows restaurant and food service employers to take a tip credit toward their minimum wage calculation for their workers. When gratuities are classified as wages, employers are no longer eligible for the tip credit.

To simplify the process and avoid having to deal with the IRS ruling, some restaurateurs are considering taking the automatic gratuity to the next level and abolished tipping altogether. Instead, they simply pay their workers a higher wage and incorporate the value of the tip into menu pricing.

Restaurant owners who intend to continue to rely on automatic gratuities should consider hiring a small business tax advisor or financial consultant to explore the implications the new IRS rule will have on their businesses.

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