Should You Eliminate Group Service Charges in Your Restaurant?

Joel SowalskyMany restaurants require a mandatory minimum tip or service charge for larger groups of patrons. Often this is with parties of 6 or 8 or more, and usually a charge of 18% or so is added to the bill. The restaurant commonly gives the person paying the bill the option of adding more to the tip, but there is no option to pay less.

If you own a restaurant with a policy that includes mandatory minimum tips, you may want to reconsider that policy. In 2012, the IRS issued a Bulletin on the taxation of tips. Among other things, the Bulletin distinguished between a “tip” and a “service charge”. In order to qualify as a “tip,” the payment must be completely voluntarily, and the customer must have an unrestricted right to determine the amount of the tip. If the payment or the amount is mandatory in any respect, then it falls in the category of a “service charge.”

According to the IRS Bulletin, “to the extent any portion of a service charge paid by a customer is distributed to an employee it is wages for FICA tax purposes.” This means that you must make Social Security and Medicare contributions on the amounts you pay your employees from these mandatory tips. In addition, these “service charges” must be considered as wages for purposes of computing your employee’s rate of overtime pay. If your employee works more than 40 hours in a week and is paid “time and a half,” then you must include the mandatory tips as part of your employee’s regular rate of pay for purposes of computing the overtime rate. This means that that the rate you pay for overtime hours may change every week.

The IRS is providing the following example as guidance for restaurant wait-staff employees: “Good Food Restaurant adds an 18% charge to the bill for parties of 6 or more customers. Jane’s bill for food and beverages for her party of 8 includes an amount on the tip line equal to 18% of the charges for food and beverages, and the total includes this amount. Because Jane did not have an unrestricted right to determine the amount on the “tip line,” the 18% charge is considered a service charge. Do not include the 18% charge in your tip diary. Service charges that are paid to you are considered wages, not tips.”

This new rule originally was supposed to go into effect in January 2013. However, the IRS later announced that it would delay implementation until January 1, 2014, “in order to allow businesses not currently in compliance additional time to modify their business practices and make needed system changes.” So, the new rule is now in effect.

General Counsel says: Owners of restaurants should reconsider whether you wish to continue your practice of imposing mandatory service charges for larger parties. This will increase substantially your labor costs for all employees who receive those tips. Many restaurants are eliminating their mandatory tipping policies altogether. If you decide to keep your mandatory service charge and you have wait-staff who receive them and who work overtime, be very careful to adjust your employees’ hourly overtime rate weekly on account of the mandatory tips received. The last thing you want or need is a wage claim for underpayment of overtime pay.

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