By: Trevor D. Large, Partner
September 2013
The Internal Revenue Service (“IRS”) has issued a recent update regarding classification of mandatory gratuities that should have all hospitality businesses evaluating their tipping policies. Many businesses have policies where patrons are mandated to pay a certain percentage or amount for a gratuity (such as for large groups at a restaurant). These mandatory payments will no longer be considered tips, but will now be employee wages. This can have a massive impact on employer and employee costs as well as significantly increasing the work necessary to complete monthly payrolls. Specifically, in Tax Topic 761, the IRS has stated:
Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to social security tax, Medicare tax, and federal income tax withholding. In addition, the employer cannot use these non-tip wages when computing the credit available to employers under section 45B of the Internal Revenue Code, because these amounts are not “tips.”
This can affect many more than just the typical restaurant server. The IRS noted that these charges regularly occur in the following situations:
If an employer provides these mandated charges to the employee(s), they will now be considered wages. This can greatly increase the cost and paperwork for a business. In addition to all the new taxes that must be calculated on these “wages,” this additional mandatory payment can now affect the amount of your employee’s “regular rate of pay,” which is the number used to calculate how much overtime an employee may be owed. As a result, mandatory gratuity policies are now a complication and potential liability for many businesses.
The initial reaction may be to eliminate these policies all together. Such a reaction can solve the problem for the employer. However, these mandatory policies were often put in place to prevent employees from receiving substandard tips for challenging tasks. If employers wish to continue the idea behind these policies, there can be creative ways to continue to protect these employees, while avoiding the classification of these gratuities as wages.
This is a complicated new issue that employers must deal with. Should you have any questions about how to adapt to the new IRS policy, please contact us. We look forward to partnering with you to develop compliance strategies that work for both your business and your employees
Trevor D. Large, Partner
TLarge@BFASLaw.com
(Direct) 805.966.7716
This Advisor is one of a series of business, real estate, employment and tax advisories prepared by the attorneys at Buynak, Fauver, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution of this Advisor.
