The IRS & Automatic Tipping

The IRS just recently announced that - starting in January - all automatic gratuities on diners' checks will be considered a service charge when it comes to taxes.  In other words, service charges are subject to federal withholding - as opposed to tips which restaurants leave up to its employees to claim as income.

In essence, this would mean added costs for restaurants and a financial roadblock for most servers who make most of their incomes off of tips. For those of you that aren't familiar with this policy, in most restaurants, any party of 8 or larger is usually subject to having an added gratuity onto their total bill. This would mean that there would be even more taxes on tips which many servers use as a primary source of income, instead of a weekly paycheck.

Since this ruling of the IRS was announced, most major restaurants are now planning to do away with automatic tipping percentages and offer a new system of tipping suggestions.  As an example, Darden Restaurants (the conglomerate that owns Olive Garden, Red Lobster, and Longhorn Steakhouse) show the tipping amounts for 15%, 18%, and 20% for each bill and allow a customer to pick from those or write in their own amount.

The change will complicate payroll accounting for restaurants that stick with automatic tips, because they will need to factor those tips into pay, meaning hourly pay rates could vary day to day depending on how many large parties are served. With this in mind, 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. Restaurants are eligible for an income-tax credit for some or all of those payments, but service charges aren't eligible, meaning more money coming out of the owner's pocket.

While this may not be a huge issue for large chain restaurants like most Darden restaurants, it could mean disastrous results for small, independent business owners.  While owners are not against paying their employees, it's obviously difficult to keep costs down while trying to maintain certain standards within the business.  While we're living in small town America, it shows that even we are subject to the changes and falters of our economic status now.

While we feel its effects daily, there are many people who are putting this new law under scrutiny. Many restaurants will go as far as to put a suggested tipping percentage on a bill but still allow customers to change the amount accordingly.  But in the end many people question... "Who knows how long it will be before the IRS assumes this action as a service charge?"