The Difference Between Tips and Service / Gratuity Charges

Catering, Parties and Banquets are a boom for restaurateurs. And while tipping is the norm for the rest of their business, most operators choose to impose a mandatory “service charge” on unusually large groups. .

The decision to impose a service charge brings with it a host of legal and tax issues that don’t apply to tipping. For example, sales taxes generally applies to service charges but not to tips. To help operators understand some of the other key differences between the two, here’s a review of federal and state rules concerning tips and service charges.

Definition of Tips and Service Charges

A tip is a sum given by a customer as a gift or gratuity in recognition of some service performed for the customer. Whether a tip is given, the amount and the recipient of the tip are determined solely by the customer.

A service charge is an amount added to a customer’s bill by management. It’s important to inform customers of the service charge and the amount (customarily 15 to 22 percent of the charge for food and beverages) before they order, either by notice on the menu or some other means. (Suggesting an appropriate tip amount to customers does not qualify as a service charge.)

Federal Law

Under federal law, service charges belong to the establishment, become part of its gross receipts and may be retained by management or distributed to employees in any amount management chooses.

Amounts distributed to employees from service charges must be taxed as wages. Service charges distributed to employees may be used to meet an employer’s minimum wage obligation. However, even if distributed to employees, service charges cannot be counted as tips or applied toward the tip credit.

State Sales Tax

For state sales tax purposes, gratuities are not subject to tax when all of the following apply:

1. Gratuities are separately stated on the bill and are optional for the customer.
2. No portion of the gratuity is retained by or for the profit of the business.
3. Gratuities are given to the persons providing the service.

IRS Publication 531 (Reporting Tip Income)

IRS Publication 1244 (General Information Regarding Tip Reporting)

Popularity: 20% [?]