New IRS Ruling Forces Restaurants to Classify Automatic Gratuities as Wages
Many restaurants have a policy of automatically adding a 15-20% tip for groups of eight or more—a practice many diners find annoying and even offensive. Even so, assuming the tab for your party of eight comes to $200 and the automatic gratuity of $40 is added onto your bill, that $40 will go directly to your server. The new rules which go into effect in January will reclassify these mandatory tips as “service charges” rather than regular tips. Either way you are still charged $40, but for the wait staff and the restaurant, the change could cause problems.
Wages Require Payroll Taxes to Be Withheld
Once a gratuity is classified as a service charge it becomes a “regular” wage, meaning the owner of the restaurant is required to withhold payroll taxes from the amount. For wait staff, the change means they have less money initially in their pocket along with less “wiggle room” at tax time; some servers may be less than scrupulously correct when estimating their tips for tax purposes. The restaurant owner now has to differentiate between which tips are just tips and which have changed into a service charge. Further, restaurants are required to pay Medicare and Social Security taxes on all money which is classified as wages and while they are eligible for a tax credit on some of these payments, service charges aren’t eligible.
Restaurants Considering Eliminating Automatic Gratuities
Because of the added paperwork and costs involved for restaurants, many of the larger chains are considering discontinuing the automatic gratuity practice and some have already begun phasing it out. The owner of Olive Garden, Longhorn Steakhouse and Red Lobster began phasing out automatic gratuities in July and now include a variety of “suggested” gratuity amounts, calculating the total for the customer based on a 15%, 18% and a 20% tip—regardless of the number of people. Of course diners still have the option of including a smaller tip, a larger tip, or no tip at all.
The Texas Roadhouse chain is planning to completely phase out automatic gratuities by the end of 2013. Restaurant owners with more than 50 full-time workers have also been hit with the necessity of offering health coverage to any employee who works more than 30 hours per week, so many feel this new ruling adds insult to injury. The new IRS ruling will also likely make waiters less likely to split their tips with busboys—who regularly get stiffed as it is and exist on less than minimum wage.
Are Most Tips Reported to the IRS?
The new ruling may be in response to the fact that the IRS estimates that fewer than 40% of all tips are properly reported to the agency, resulting in billions of dollars in unreported income. Tipped employees, however, often receive the majority of their income from tips with a significant portion of that in cash, lessening the motivation for employees who may make as little as $2.25 per hour to turn in all tips to the IRS.
Tax Help When You Need it Most
As a restaurant owner who is uncertain how the new IRS ruling will affect your business, a waiter who is wondering how the new ruling will affect your ability to pay your bills, it could be helpful for you to speak to Louisiana tax attorney, Paul A. Grego. Mr. Grego offers a free consultation in order to respond to your questions and prepare an initial assessment of your tax situation. If you have tax questions regarding the new IRS ruling or any other tax questions we have the tax knowledge and experience necessary to answer those questions and ensure you stay “right” with the IRS. Call 504-302-4949 today to speak with a knowledgeable Louisiana tax attorney.