Friday, September 6, 2013

New IRS Rule Counts Automatic Tips As Income

An updated tax rule is causing restaurants to rethink the practice of adding automatic tips to the tabs of large parties.  Starting in January 2014, the Internal Revenue Service will begin classifying those automatic gratuities as a service charge.

What most people don't know is that restaurants pay their staff around $4 or less per hour.  Tips or "gratuities" are allowed by law to make up the difference to the minimum wage.  Restaurants, no matter what you receive in tips for the day, will add your tips to your income earned for the day (based on sales) to ensure you make minimum wage.  No, that does not mean they actually pay you, the restaurant "assumes" you've earned the difference.  Yes, those coupons and early bird special hurt.  Currently, restaurants are required to report to the IRS what its employees report receiving for tips and to pay Medicare and Social Security taxes on those amounts.  Naturally, restaurants are able to save millions collectively on payroll and income taxes.  Servers, at least at the expensive places, can earn quite a bit and avoid the tax man on a good portion...assuming they aren't completely honest.

Restaurants in many European countries pay their staff full wages.  Tips are a Euro or two in German, 20-20 cents in Belgium, and a Euro at most in Austria....just enough to round up.  That's a win-win for everyone involved.  The staff get paid a steady wage, with extra for a good there is no rushing you out the door so they can get the next table seated.  Put the bill on the table before the customer has asked for it is liable to get you yelled at.

What gets this authors goat is the automatic tip added to the bill if you have, generally, six or more people at the table.  Frankly, when that happens I don't give my usual 20%.  I do that on principle.  Restaurants supposedly adopted automatic gratuities to help ensure that their servers weren't stiffed on large tabs, which I frankly doubt.  Most business adopt policies to help themselves, not their employees. But the new IRS ruling (from 2012) is getting frosty support from many servers and restaurants who don't like the idea of tips being treated as wages.  Wages requires upfront withholding of federal taxes, and that money will have to be paid out on a payday vs. in cash that day.  Likewise, restaurants will have to pay additional income, social security, medicare and other taxes on those wages.

The IRS ruling was issued in 2012 to clarify earlier tax guidance on tips, and note how automatic tips were to be treated.  The updated rule says the automatic tips are service charges because they aren't voluntary. However, the IRS did say that suggesting different tip amounts isn't subject to federal withholding because the customer is still free to choose whether and how much to tip.

Personally, I want tips eliminated altogether.  Let the restaurants pay a wage like any other business.  If I choose to leave an extra few dollars for outstanding service, then that should be my choice, not a social obligation.

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