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December 5, 2013

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IRS ruling on automatic gratuity begins January 2014

Effective Jan. 1, 2014, the Internal Revenue Service (IRS) will recognize automatic gratuities, a percentage automatically added to a restaurant bill, as a service charge, rather than a tip.  The IRS ruling on automatic gratuities isn’t a new law, having been issued in June 2012 as part of an effort to update earlier tax policies on tips.  However, implementation was delayed to allow restaurants and related businesses more time to comply.

The IRS regards service charges as regular wages which must be reported for payroll tax withholding under the Federal Insurance Contributions Act.  Additionally, any portion of a service charge that is distributed to an employee is considered part of the wage for FICA tax purposes.

The following shows how the ruling defines a payment as a tip:

  • Payment must be made free from compulsion.
  • The customer has the unrestricted right to determine the amount.
  • Payment should not be subject to negotiation or dictated by employer policy.
  • Generally, the customer has the right to determine who receives payment.

The IRS urges employers to remind their workers that “all cash tips received by an employee are wages for FICA tax purposes and, therefore, must be reported to the employer.”  Cash tips specifically include the tips servers receive from customers, tips charged on credit cards, “and tips received from other employees under any tip-sharing arrangement.”  The ruling provides guidance for employers and employees in a question and answer format regarding taxes imposed on tips under the Federal Insurance Contributions Act, including information on the difference between tips and service charges, as well as the reporting of the employer’s share of the FICA.

For more information, visit the CRA Legal Center or call the CRA Helpline at 800.765.4842, Ext. 2743.

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