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When is a tip not a tip but a service charge instead? Sound like hair splitting? Well, not according to a new IRS rule that will go into effect this coming January.

Here’s the background story. Many restaurants charge automatic gratuities of 15% to 20% for large parties. Treated as tips, these amounts have been paid to restaurant workers along with their other tips, and the workers have been responsible for reporting them as income to the IRS.

According to the IRS, a payment from a customer can only be considered a tip if the following is true:

  • the payment is not compulsory
  • the amount is decided by the customer
  • the payment is not dictated by employer policy
  • the customer is free to decide who receives the payment

If the payment is a specified amount added to the bill for large parties, it’s a service charge, not a tip, says the IRS. Service charges are treated as regular wages subject to withholding by the employer.

This ruling complicates income reporting for both restaurant employees and employers. For assistance in getting your bookkeeping ready to deal with this new rule, give our office a call.