Our HR Support Center recently addressed the new IRS guidelines for Automatic Gratuities. Effective January 1, 2014, automatic gratuities in the hospitality industry (for example, an automatic 18% tip for parties of six or more) will be treated by the IRS as service charges rather than tips. Unlike optional tips which the employee bears the responsibility of reporting, these service charges will be viewed as wages and the employer will be responsible for reporting them. Additionally, employers should be aware that any such service charges will be considered part of the employee’s regular rate of pay for purposes of calculating the overtime rate.
Per the IRS, in order for a payment to be treated as a tip, generally all of the following factors must be met:
1) The payment must be made free of compulsion;
2) The customer must have the unrestricted right to determine the amount of the payment;
3) The payment may not be dictated by employer policy or be the subject of negotiation; and
4) Generally the customer must have the right to determine who gets the payment.
If any of these factors cannot be satisfied, the payment is likely a service charge. We recommend that hospitality industry employers review their gratuity policies as well as their reporting and recordkeeping practices to ensure compliance with the new rule.