New IRS Rule Causes Restaurants to Rethink Auto-gratuities

A new IRS tax rule has restaurants rethinking the practice of including a gratuity in the amount due on checks presented to large parties.  Effective January 1, 2014 the Internal Revenue Service will classify automatic gratuities as wages, subject to payroll tax withholding—instead of tips, which are made at the customer’s discretion and reported to the IRS by the employee, only, not by the employer.

In other words, the IRS has decided that “automatic gratuities” aren’t really tips at all, but service charges that should be considered part of the restaurant payroll!  You can read more about the rule on the IRS website:

IRS Topic 761 – Tips: Reporting & Withholding

What does this mean for restaurant owners?

This change has several potential consequences for restaurant owners:

More complicated payroll calculations: Restaurants will be required to adjust the gross salary earned during each pay period to include the amount of any “auto gratuities” paid out to a given employees.

Higher taxes: When employee wages go up, their employers’ tax liability goes up as well. For example social security contributions will be higher for employees who receive a large amount of these service charges as part of their wage.

Dissatisfied employees: Your staff’s tax burden will go up right along with your own, leading to some unhappy servers.  Additionally, severs will need to wait to take home cash earned this way until their next paycheck, rather than pocketing it the night the customer pays the gratuity.

What should you do?

The cleanest way to comply with the new IRS rule is to stop charging automatic gratuities entirely.  Alternatively, restaurants can upgrade their POS System to a solution that includes auto gratuities in payroll calculations.  The one thing you don’t want to do is NOTHING.  Manually tracking unpredictable variations in employee wages after the fact is an unnecessary cost that restaurants need not – and SHOULD NOT – incur.

Whether you stop charging auto gratuities or start including these gratuities in your payroll calculation, it’s important to communicate with your staff prior to making any changes.  Make sure they understand that outside forces – the IRS to be exact – are requiring you to change company policies.  And demonstrate that you’re trying to comply in a way that causes them the least harm possible.  For example, if you do decide to stop charging automatic gratuities, you might consider re-designing guest checks so that, under the actual check total, customers can see the total amount they should pay if they wish to leave a 15%, 18% or 20% tip.  Sometimes a simple change like a re-designed check format can go a long way in boosting staff morale.

Author: Remigijus Pavydis