The days of servers banking on large groups as a sure thing for a tip are gone—or at least will be soon.
In 2012, the IRS redefined how restaurants must classify automatic gratuities, often charged on parties of six, eight, or larger. But implementation of the change was delayed, with full enforcement beginning Jan. 1, 2014. No longer can restaurants and banquet halls count these automatic charges as tips—rather, they must be accounted as earned income.
While enforcement has been in effect for a year, experts say restaurants that have resisted the change should not hold out any longer in 2015, as the IRS moves toward cracking down on stragglers.
The IRS is giving restaurants a choice: They can ditch the automatic gratuity and make the charges optional tips, or they can charge an automatic service charge, which would be subject to sales tax and payroll tax withholding and would require restaurants to pay servers the full minimum wage.
Restaurants may suggest tips on large parties, but the IRS says those payments “must be made free from compulsion” by customers in order to count as a tip and not as regular wages. That means tips can’t automatically be added to a large group’s check. IRS Ruling 2012-18 also states customers must maintain the unrestricted right to determine the tip amount. The payment should not be the subject of negotiation or dictated by employer policy, and the customer generally has the right to determine who receives the payment.
Anil Melwani, a certified public accountant and managing partner of New York City’s 212 Tax & Accounting Services, says the change is causing administrative and bookkeeping stress for restaurants and nightclubs that count on business from large groups.
“But it’s a much bigger hit to the employees,” he says. “These automatic gratuities were usually adding 18, 20, or 22 percent. Now you’re leaving it up to the client; that means servers are making less in tips, which is a majority of what they make. It definitely hits the employees.”
It’s unclear when the IRS will ramp up enforcement, Melwani says. He hasn’t seen the IRS bust any restaurants for failing to make the change. But he’s advising his restaurant and nightclub clients to take the regulation seriously. The change comes at a time when the IRS and the U.S. Department of Labor were already targeting the foodservice industry for wage and labor infringement.
“It’s been around for enough time where you can’t really say, ‘I didn’t know about it,’” he says. “It’s definitely the time [to put it into practice].”