Restaurant Financial Management: Automatic Gratuities Soon to be Treated as Wages

Starting January 1, 2014 an IRS ruling says automatic gratuities will start to be treated as wages not as tips.  The IRS ruling states that automatic gratuities are actually service charges because they do not meet the requirements to be reported as tips.  In order to be treated as tips, the payment must be made freely and the customer must have the unrestricted right to determine the amount.

This may cause some restaurants to rethink their policy on automatic gratuities when it comes to large parties.  Because of the additional record keeping required to determine a service charge and then properly report that charge as a wage versus a tip, many restaurants may go away from the automatic gratuities regardless of the size of the party.  The IRS has said that the restaurants may present a bill that includes sample calculations of tips at various percentages, but the tip line itself must remain blank and completely up to the individual.

Since the automatic gratuities will be considered services charges they will be reported as part of gross revenue on the profit and loss statement of the restaurant.  The service charge collected will then be paid to the server, however it will be paid in a paycheck, and therefore reported as a wage on the profit and loss statement.  Therefore, the net effect to the restaurant’s profit and loss statement is zero.  Since it will be paid to the server as a wage in a paycheck, it will be subject to all of the withholding taxes normally associated with wages.

Because the payments will now be considered service charges, and not tips, the payments will not be eligible for the FICA tip credit and are not eligible for the general business credit.

Need assistance with restaurant financial management? Contact Kirk Trowbridge at 614.545.9200 x29.

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