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Automatic Tip Charges for Large Parties in Restaurants: New Classification as “Service Charges” Not Reported on Form 8027

October 23rd, 2014 No comments

In January of this year, the IRS changed a long-standing rule on automatic gratuities in restaurants for large parties.  Typically for parties of 6 or more guests, a restaurant will charge an automatic 18 to 20 percent to make sure that the gratuity is adequate to compensate the server.  These automatic tips have always been viewed for tax purposes the same as any tips for wage and tax purposes.  Any food and beverage employer with more than 10 employees reports all tips on Form 8027 each year.  The new IRS rule now includes these large party gratuities as “service charges”, classifying them as simple wages rather than tips, affecting reporting for both the employee and employer.

Service Charges as Regular Wages and Not Tip Income

Historically, tip income is used to offset the amount of minimum wage paid to employees.  Since the automatic gratuities will now be seen as service charges, that means that employers will not get a “tip credit” for those amounts to offset minimum wages paid to wait staff.  This could raise their labor costs by requiring more wages to be paid to staff, even while the employee receives the same amount of tips.  Another employer burden is where a single waitperson serves both large and small parties in the same shift.  In that case, the tips received would have to be allocated based on party size, as well as the hourly rate paid to the employee.  The only real solution would be to designate some wait staff as “only large party” employees for the shift.

Reporting Automatic Gratuities as Service Charges

The employer reports tip income on Form 8027, based on all cash tips disclosed by the employee, as well as those on credit slips.  The automatic gratuity “service charge” would now be reported as wages only and not included on Form 8027.  The service charges would now be reported on Form W-2 as regular wages to the employee.  This removes the automatic gratuities from the 8% computation of allocated tips on Form 8027 based on gross receipts, which is the IRS baseline to make sure that all tip income is reported and taxed.  This is a complex computation made more so by the new rule on automatic gratuities.

The approach by many restaurants to this new rule has been to eliminate the automatic gratuity on large parties, and only “suggest” tip amounts to customers.  While this seems to eliminate the tax and reporting burden, it does place the wait staff at risk of receiving lower gratuities from customers who are no longer bound by mandatory tip amounts.

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