United States

Automatic gratuities: Tips or service charges - Part II


The first article titled Automatic gratuities: Tips or service charges appeared in the August 2012 issue of this newsletter. In it, several comments were offered regarding the Internal Revenue Service (IRS) revenue ruling 2012-18 issued on June 20, 2012. This revenue ruling reiterated the four requirements that must exist for a payment to be classified as a tip.

As indicated in that article, some private clubs, which traditionally have forbidden the practice of cash tipping, have elected instead to have an automatic gratuity charge on the member's checks. Gratuity policies are disclosed on checks or noted on menus or in the rules and regulations for some clubs.

Since that article, emails and phone calls have rolled in asking for more clarification on this topic. One such caller inquired whether anything had really changed. The response: "No."

However, the point to take away is that many clubs which use the practice stated above may not be adequately following the rules in order for the payment to be seen as a tip from the perspective of the IRS. Documentation is critical for supporting a club's position that the automatic gratuity is a tip.

Labor Department regulations define a tip as:

"A tip is a sum presented by a customer as a gift or gratuity in recognition of some service performed for him. It is to be distinguished from payment of a charge, if any, made for service. Whether a tip is to be given, and its amounts are matters determined solely by the customer, and generally he/she has the right to determine who shall be the recipient of the gratuity."

Labor Department regulations permit the practice of pooling, splitting or sharing tips as long as the employees in the pool customarily and regularly receive tips. Employees who customarily and regularly receive tips are waiters, waitresses, countermen, busboys and service bartenders. Also likely included would be captains and maitre d's who regularly provide service to dining club members. The tip pooling or distribution should be clearly understood by the service employees and no portion of the tips may be retained by the employer. Furthermore, if the employer is taking a tip credit against the employees' hourly rate, employees must be informed about the specifics of their hourly wage, tip credit and net hourly wage.

In addition, since tips are considered the property of the employee receiving them, tips due to employees must be paid no later than the next regular payroll without any regard to their reimbursement from club members.

Since many clubs have a stated policy that permits the member to increase, decrease or eliminate the gratuity charge entirely, any instances where this occurs should be maintained in a separate file as evidence in case a wage and hour or IRS audit should occur.

Finally, the charge ticket that includes the imprinted automatic gratuity should be signed by the member evidencing the member's approval for the payment of the gratuity.

Remember that there must be documentation to show that: 1. The payment is voluntary; 2. The club member is determining the amount by having the option to increase, decrease or eliminate entirely; 3. The payment or distribution is not dictated by employer policy or subject to negotiation; 4. The club member generally has the right to determine who is entitled to the payment. If even one of these four criteria is not met, then the payment is not a gratuity or tip.

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