New IRS rule may end automatic gratuity in restaurants

Automatic tips added to large parties' restaurant tabs may disappear due to updated tax rule.
Posted By KRISTEN BUTLER,  |  Sept. 5, 2013 at 12:40 PM
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Many restaurants have long-standing policies for adding an automatic gratuity to the tabs of parties of six or more, but an updated tax rule may change that.

Beginning in January, the Internal Revenue Service will classify automatic gratuities as "service charges" rather than tips because they aren't voluntary. The distinction allows the IRS to treat those gratuities as regular wages subject to payroll tax withholding.

Many point-of-sale systems already require servers and bartenders to report tips paid with credit cards, and those tips are reported by the restaurant and subject to Medicare and Social Security taxes. Cash tips are largely the responsibility of the server to report as income.

But the change will mean more paperwork and added costs for the restaurants, as the automatic tips -- which fluctuate from day to day -- will have to be factored and taxed as wages.

Darden Restaurants, owner of Olive Garden and Red Lobster, has already eliminated automatic gratuity at 100 restaurants in four cities in preparation.

To address the longstanding problem of large parties often tipping less for more labor, Darden is experimenting with customer checks that come printed with three suggested tip amounts already calculated.

All bills, regardless of party size, are printed with the calculations for adding a 15, 18 or 20 percent tip to the total. If the new checks are received well by customers and work to prevent servers losing tips on large tabs, automatic gratuity could be eliminated company-wide by year-end, and other restaurants are expected to follow suit.

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