Proper tax planning and tax preparation considerations need to be addressed by many business owners because of an IRS ruling. Effective January 1, 2014, if a business adds service charges to customers’ bills which it distributes to its employees, the amounts distributed to the employees will no longer be considered tips.
What is a “service charge” or “auto-gratuity”? By way of example, these are the automatic tip charges for large parties (used by restaurants), a bottle service charge (restaurants and night-clubs), room service charge (hotels and resorts), a contracted luggage assistance charge (hotels and resorts), or a mandated delivery charge (pizza, Chinese restaurants and other retailers).
This change is causing some restaurants to rethink the practice of adding automatic tips to the tabs of large parties. Why? Because the IRS will begin classifying those automatic gratuities as service charges which are considered as regular wages subject to payroll tax withholding (IRS Rev. Rul. 20012-18, Announcements 2012-25 and 2012-50).
The change will complicate payroll accounting for restaurants that stick with automatic tips. They will need to factor those tips into pay, meaning hourly pay rates will vary daily depending on how many large parties are served. Since employers are required to make up the difference between the servers’ actual hourly wage and the minimum wage for employee Social Security and Medicare wage reporting and actual wages paid is used to compute the FICA tip credit, the employer will be responsible for more payroll taxes and the associated compliance cost of tracking these auto-gratuities.
Most restaurants are able to track credit card tips to their servers, but depend upon the servers to report cash tips. For those restaurant servers whose employers do not track employee tips and depend upon the servers to properly report their tips, this could possibly pose a financial hit to those servers. Servers could also experience a hit to their cash flows. Tip money is usually distributed to the servers at the end of their shift. If the automatic gratuities are included as wages, the server would not see that money until pay day.
Note: Because each business has unique factors that need to be examined when determining its tax situation, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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