Many restaurants that continue to include automatic gratuities on checks for large parties of six or eight will face additional paperwork and costs due to an IRS Ruling that takes effect January 1, 2014. The IRS Ruling is in fact not new, having been adopted in June 2012; however, implementation was delayed so restaurants had time to comply.
So, what’s the change? Beginning on January 1, 2014, the IRS will begin classifying automatic gratuities as a service charge instead of a tip, which means that the wages are subject to payroll tax withholdings. The change will complicate accounting and bookkeeping for restaurants, according to a recent article in The Wall Street Journal. It also could lead to a loss in income tax credits that restaurants receive for paying Medicare and Social Security taxes on employees’ reported tips. The credit is not available for service charges.
Some restaurants are instead switching to a suggested tip amount of 15%, 18% or 20% on all checks regardless of the party’s size. This change gives restaurant patrons the choice to leave the suggested amount, a different amount or nothing at all, which makes the payment a tip rather than a service charge.
IRS Bulletin: 2012-26 provides further guidance for restaurant owners and accountants.