United States

Automatic gratuities: Tips or service charges

ECLUB NEWS  | 

A recent Internal Revenue Service (IRS) revenue ruling should force clubs and other food and beverage service establishments to evaluate gratuity policies. Revenue Ruling 2012-18 issued on June 20, 2012 is an attempt to clarify and update existing guidelines and the distinction between tips and service charges.

The revenue ruling states that the IRS will continue to apply existing criteria in order to determine whether a payment is a tip or a service charge. Under Revenue Ruling 59-252, four requirements must exist for a payment to be classified as a tip. Those four requirements are:

  1. The payment must be made voluntarily without any compulsion.
  2. The customer must be free to determine the amount of the payment.
  3. The payment cannot be dictated by employer policy or be subject to negotiation.
  4. The customer must generally have the right to determine who is entitled to receive the payment.

The absence of any of these actions indicates that the payment may be a service charge rather than a tip and therefore includable in the employee's wage base for overtime and as a result the employer may not take advantage of the tip credit permitted for employees who regularly receive tips or the fica tip credit as a tax credit on their income tax returns.

Clubs have traditionally forbidden the practice of cash tipping in their food and beverage establishments, instead, electing the use of an automatic gratuity charge on the member's check.

Clubs often disclose to the members the policy on tipping through such statements as, "For your convenience a recommended gratuity of ____% is added to this check. The payment of this gratuity is subject to your complete discretion and may be increased, decreased or eliminated entirely." In this way, the club is permitting the member to have complete discretion as to the payment of the tip or gratuity.

However, it is unlikely the customer or, in this case, the member really thinks about whether this payment is discretionary or not. In some cases, members never even sign their checks and there is no evidence that the member has approved the amount. Furthermore, members for the most part, have very little knowledge or influence as to how the tip or gratuity is pooled and distributed.

Clubs that are using this technique to provide tips for their service employees should revisit whether the gratuity charge actually meets the four requirements listed above.

For additional questions or information, contact Bob Salmore at bob.salmore@mcgladrey.com.

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