Tips or Service Charge? Guidance for restaurant owners and servers

There’s new guidance out on whether a payment by a diner is a tip or a service charge.  (For a primer on how to handle the taxes on tip income for servers, take a look here.)

In the new guidance, the IRS attempts to clarify the difference between a tip and a service charge.  A service charge is to be treated as wages, not tips.  Service charges are not to be included in any calculation that arrives at an hourly tip rate, a tip rate calculated on percentage of sales, or any other rate determination method.

Here are the criteria for how the IRS views tips:

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

So, for example, if a restaurant has a policy that automatically adds a gratuity of 18% for all parties over 8 people, and the money is split among the servers and bussers, then that would be a service charge.  If a restaurant leaves the tip line blank on a bill, but the restaurant shows sample tip calculations of 15%, 18%, and 20%, then the amount filled in by the customer would be treated as a tip.



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