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Mandatory Gratuities Aren’t Really Tips, Says the IRS

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Mandatory Gratuities Aren’t Really Tips, Says the IRS

tip

Most restaurant owners understand how difficult it is to serve groups of 6-8 or more seated at one table. Many restaurants will assign a waiter solely to serve a group of 8 or more patrons. But, a year old IRS ruling, going into effect in January 2014, could make serving large groups even more of a business nightmare.

Traditionally, restaurants were allowed to classify mandatory gratuity as tips and therefore, avoid paying payroll taxes. Under the ruling, FICA taxes, such as Social Security and Medicare would be paid by restaurants for the full amount of the tip/service charge. Further, the tips would be subject to a higher rate than in the past few years with the expiration of the Bush-era tax cuts.

In Revenue Ruling 2012-18, the IRS laid out four factors in determining what exactly a tip (and therefore not subject to FICA withholding) is. They included that (1) the payment must be made free from compulsion, (2) the customer must have the unrestricted right to determine the amount, (3) the payment should not be the subject of negotiation or dictated by employer policy and (4) the customer has the right to determine who receives the payment.

This ruling regarding mandatory tips and service charges, which the IRS has given restaurant owners until January 2014 to comply with, is expected to result in the elimination of most mandatory gratuities at restaurants, as owners attempt to find a way to additionally compensate their busy staff without having to incur any additional tax liability.