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New(ish) IRS Rules on Automatic “Gratuity”

Posted by McDonald & Osborne Posted on Oct 14 2015

When automatic “gratuity” first appeared, it typically only applied to large parties dining in restaurants. Quickly though, other service industry providers jumped into the mix such as pizza companies who charge “delivery service fees” and hotels applying “room service charges” to your bill. Regardless of your opinion of such automated gratuity, the practice may be going away in the very near future thanks to new IRS rules related to the treatment of such fees.

G.E. Miller describes the practice of automated gratuity as an oxymoron in his latest blog post, “Automatic Gratuity Will Soon be a Thing of the Past” . He comically breaks down the issue, giving the details of the new rules and how they will apply. In reality, the rules changed in 2012 but the IRS will begin enforcement in 2014. IRS Tax Topic 761 now treats automated service charges as wages to employees rather than tips . This is a big deal to employers because while both are subject to Social Security, Medicare and Federal Income Tax Withholding, businesses may receive a tax credit for FICA and Medicare taxes they pay on the tips. This credit does not apply to such taxes paid on wages.

The rule change does not ban an employer from the automated tip practice but we have a sneaking suspicion that most will go back to the old ways of making their employees earn tips voluntarily so that they may still qualify for the special tax credit.

Stephen Osborne