IRS Rule Leads Restaurants to Rethink Automatic Tips

September 9, 2013 — Leave a comment

Currently, restaurants such as Olive Garden, LongHorn Steakhouse and Red Lobster (all owned by Darden Restaurants Inc.) add an automatic 18% tip on bills for parties of eight or more. However, with a new Internal Revenue Service rule in play, these restaurants will look to eliminate the automatic tips for tax purposes.

Starting in January of 2014, the IRS will begin classifying those automatic gratuities as service charges. The updated rule says the automatic tips are service charges because they are not voluntary. It will now treat them as regular wages, subject to payroll tax withholding. Restaurants typically leave it up to the employees to report tips as income.

Darden Restaurants Inc. has stopped automatic tips at 100 restaurants in four cities, where it is testing a new system in which the restaurants include three suggested tip amounts, calculating for the customer the total with a 15%, 18% or 20% tip on all bills, regardless of party size. Depending on how restaurant-goers deal with the change, the restaurants will all move to suggested tips.

“I think the vast majority of restaurant owners will discontinue the practice,” says Denise Wheeler, an employment attorney in Fort Myers, Fla., who represents several restaurant chains. She notes that 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.

Additionally, the rule adds more financial burden on restaurants because restaurants with fifty or more employees will now have to offer health coverage to employees working over thirty hours a week otherwise they will start incurring penalties.

Servers at restaurants often have base wages lower than the federal minimum wage of $7.25 and because of that, restaurants have used the automatic gratuity charge to make sure servers are not stiffed on tips.

Many employees are against the IRS rule and will want to use the suggested tip to support their income. If not, tips will be withheld for payroll tax purposes and the employee will not see the tips until payday.

“I don’t want my tips to be on my paycheck as a wage. I like to get my tips at the end of my shift because I know what I’m getting right away,” says Tamie Cordoba, a 54-year-old server at a LongHorn Steakhouse in Jacksonville, Fla.

In Yahoo Finance’s article on the IRS rule, it notes that Ms. Cordoba makes base wages of $4.25 an hour, or $144.50 to $161.50 for her average workweek of 34 to 38 hours. She said she usually makes an extra $500 to $650 a week in tips. “In this industry, that’s what we live on. If I had to wait two weeks I don’t know how I’d survive.” She points out that getting paid at the end of the shift helps her with her weekly budget.

To help out with the rule, the IRS has provided an example, similar to the experiment of Darden Restaurants Inc., of a restaurant suggesting different tip amounts, and said that practice is not subject to federal withholding because the customer is still free to choose whether and how much to tip.

JDKatz: Attorney's At Law

JDKatz, P.C. is a full-service law firm focused on tax lawbusiness and transactional lawestate planning and elder law. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys, or visit http://www.taxattorneymd.com.

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