Gratuity: Taxation and Management of Tipped Employees

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January 7, 2014 — 2,849 views  
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Come January 2014, the IRS (Internal Revenue Service) will categorize automatic gratuities under service charges. This move will make gratuities liable to payroll taxing as they will be considered as regular wages. The ruling, which had been issued in 2012, while updating the tax policy on tips, has been delayed until now. Industries had requested the IRS to hold it off for a year so it would give them the time to adhere to the requirements. The ruling will not only affect the beverage and food sectors, but also restaurants, resorts, delivery services and other industries where tips are prevalent. Before the ruling came to the front, automatic gratuity was not regarded as regular wage. This was particularly beneficial to those who heavily relied on tips to aid their minimum wage pay.

What This Means for Employers

The new definition of what classifies as a tip is a payment that is made without compulsion, where the customer determines who gets the payment and what the amount is. Also, the payment must not be ruled by any employer policy or subjected to negotiations. A mandatory charge will be regarded as an ordinary wage and not a tip. If an auditor finds a tip to be a service charge, it could have a major impact on the employer's tax liability under employment, as it would be no different than paying cash to an employee.

The IRS is urging employers to inform their workers that tips received by employees are wages and that they should be reporting it to their employers. They mentioned that employers should clear it out with employees on whether payments come under service charges or tips, so they are reported by them correctly. Else, they could be wrongly filed by being reported more than once. According to the IRS, the ruling will not affect the restaurant payroll taxes majorly if the tips are duly reported to the employers. It says that the employer will have to bear negligible tax changes if all employees report their tips accurately.

But the move could complicate the payroll accounting process. Treating gratuities as regular wages will require for the employers to make changes to ensure that the gratuity incomes are rightly classified. Complying with the norms and making changes in payroll and accounting will also not be an easy task for employers. A good solution that many are seeking out for is to outsource payroll processes to companies that can get the information from the POS (point-of-sale system), directly to the payroll.

How This is Panning Out

Given the expenses and time involved in keeping track of tax records, many industries are looking at dropping their automatic gratuity policy. Some industries are giving customers the choice to tip as much as they want or leave no tip, as they wish. Few services are including 'suggested tip' boxes in their checks, so the customers remember to tip them without having to deal with complex payroll processes.

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