The deviation betwixt tips and service charges can exist confusing for employers, merely information technology is critical that they make the correct distinction. Whether a gratuity is a tip or a service charge impacts how employers calculate their employees' wages and how income is reported by employers and employees for tax purposes. A mistake in characterizing these ii forms of compensation can subject field employers to penalties under the Fair Labor Standards Act (FLSA) and the Internal Revenue Code (IRC). To assistance employers, the IRS issued an updated Fact Sheet (FS-2017-08) on April 25, 2017 outlining the key differences between tips and service charges.

When is a Gratuity a Tip?

The IRS sets along 4 requirements in social club for a gratuity to be considered a tip:

  1. The payment made must exist free from coercion;
  2. The customer must accept the unrestricted right to determine the amount;
  3. The payment should not be the subject field of negotiations or dictated past employer policy; and
  4. The customer has the right to determine who receives the payment.

Just put, to be a tip, the gratuity must be completely discretionary, i.e., the client decides (1) whether to provide the gratuity and (2) how much gratuity to provide.

Forms of Tips

Tips may appear in two forms: greenbacks tips and noncash tips.

Greenbacks tips are monetary tips received by the customer, whether in the form of actual cash or credit/debit charges. Cash tips also include monetary tips received from other employees under a tip-sharing arrangement. For case, waiters and waitresses often share a portion of their tips with hostesses, bussers and service bartenders. Employees who receive tips directly from the customer are known equally "directly tipped employees." Employees who receive tips from other employees, such equally the hostesses, bussers and service bartenders in the above scenario, are known as "indirectly tipped employees."

Noncash tips are nonmonetary tips, such as passes, tickets, or other goods and commodities.

Tip Reporting

Employees: Employees must report all tips received in their gross income for revenue enhancement purposes. This includes both cash tips and the value of any noncash tips. Employees are also required to report greenbacks tips (except for tips for any month that total less than $xx) to their employer. Yet, the employee reporting requirement excludes noncash tips. For instance, if a customer leaves a waitress an expensive piece of jewelry, the waitress must include the tip in her gross income, but is not required to report it equally a tip to her employer.

Employers: Employers are required to keep employee "tip reports" in society to withhold income taxes, Social Security and Medicare taxes on reported tips from wages. Additionally, employers must pay their share of Social Security and Medicare taxes based on the full wages paid to tipped employees as well as the reported tipped income.

Tip Credit: In one case an employee receives a tip from a customer, the tip goes into the employee's pocket and can never become the property of the employer. All the same, the FLSA allows employers to take a "tip credit" towards their minimum wage obligation, equal to the deviation between the federal minimum wage ($7.25) and the required cash wage ($2.xiii), or $5.12 (the maximum tip credit an employer can merits). Any tip credit claimed by an employer can never exceed the actual amount of tips received by the employee. Additionally, the tip credit cannot exist practical unless the employee has notice that the employer is taking a tip credit.

When is a Gratuity a Service Charge?

The IRS Fact Sail reminds us that "automatic gratuities," or gratuities imposed on the customer, are not tips. But put, a gratuity included in a bill is non a tip. Examples of service charges include an 18 percent gratuity imposed on a tabular array of x or more than, an issue fee imposed on a customer who rents out all or a portion of a restaurant for a rehearsal dinner, canteen service charges or fifty-fifty corkage fees.

Employers may go on these service charges or pay a portion to their employees. If distributed to an employee, service charges constitute not-tip wages paid to the employee and should be treated as regular wages for tax withholding and filing purposes.

Overtime Issues

Sums distributed to employees for service charges may be used to satisfy an employer's minimum wage and overtime obligations under the FLSA. Overtime must exist paid based on the employee's regular charge per unit of pay, including all service charges, commissions, bonuses and other enumeration received. Under certain circumstances, an employer may be able to claim an additional overtime tip credit. Where the employer takes a tip credit, overtime must be calculated on the full minimum wage, not the lower greenbacks wage payment.

Employers should familiarize themselves with IRS Fact Sail FS-2017-08 likewise as FLSA Fact Canvass 15, regarding tipped employees, to ensure compliance with federal wage calculation and income reporting requirements. A helpful nautical chart identifying the differences between tips and service charges is displayed below.

Type of Gratuity/Compensation

Tip

Service Charge

Source

Customer

(Discretionary)

or

Other Employee

(Tipping Pool)

Employer/Restaurant

(Imposed)

Forms/Examples

Greenbacks, Debit or Credit Charges (Cash Tips)

Tickets, Passes, Appurtenances, Commodities (Noncash Tips)

Automated Gratuities

Feast/Event Fees

Bottle/Cork Fees

Reporting Requirements

Employee must report cash tips to employer and all tips as income

Employer must withhold tip income from wages

If distributed to employee, reported as regular (not-tip) wages

About the Authors

Annette Idalski

Annette A. Idalski is a shareholder and chair of the Employment and Labor practice at Chamberlain Hrdlicka (Atlanta). She defends employers nationwide against multi-plaintiff and single plaintiff lawsuits involving contained contractor status, wage and hour compliance, declared bigotry involving sex, race, historic period and disabilities, sexual harassment, restrictive covenants, whistleblower actions and traditional labor matters. She may be reached at (404) 658-5386 or by email at annette.idalski@chamberlainlaw.com .

Mary Claire Smith

Mary Claire Smith is an attorney in Chamberlain Hrdlicka's Labor and Employment exercise. She defends employers in federal and state courts and administrative proceedings involving claims alleging bigotry, harassment, retaliation, wage and hr problems and disability and leave claims under the Family unit and Medical Leave Act (FMLA). She may be reached at (404) 658-5474 or past email at mary.smith@chamberlainlaw.com.