Food Service & Agriculture, Government, and Retail

Automatic 18 percent tip will disappear Jan. 1

New IRS rule says mandatory restaurant tips aren’t tips at all.

November 15, 2013
| By Pete Daly |
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Jeff Lobdell, second from right, a principal in Restaurant Partners, said the wait staff at his restaurants do not get an automatic 18 percent gratuity on large parties. Instead, the receipt shows patrons what the tip would be at various percentages of their bill. Courtesy Restaurant Partners

(As seen on WZZM TV 13) Restaurant patrons who have been irritated by the 18 percent tip some places slap on a group check will have something to celebrate besides the new year on Jan. 1.

A new IRS revenue ruling, which was first announced in 2012 and then put on hold, will take effect Jan. 1, and it spells the end of what restaurateurs call the “automatic gratuity.”

CPA Claude Titche III, a tax partner at Beene Garter in Grand Rapids, said the IRS has determined if the customer “does not have a choice but is told they have to make a specific payment, then that is called a ‘service charge,’ and a service charge under this new revenue ruling is deemed to be compensation to the wait staff, instead of a tip. And if it’s compensation, it is supposed to be included in their W2 and have all the various withholdings taken.”

He said the IRS revenue rule “says a tip has to be free from compulsion, so it can’t be specifically stated on the bill that you are going to pay 18 percent. A customer is supposed to have the unrestricted right to decide whether to make that payment — and that includes deciding how much.”

The amount is not subject to negotiation between the restaurant and the customer, he said. “It’s truly a gift or payment made by the restaurant patron in appreciation for service.”

Titche said there was an “uproar” from restaurant chains when the IRS issued the ruling in 2012, and the IRS deferred the implementation until Jan. 1, 2014.

“Restaurants don’t like that (ruling) because it’s going to be a pain in their rear” trying to update employees’ W2s and payroll tax filings to include those occasions when they received the increased compensation, according to Titche.

Service charges passed on to employees will be treated as regular wages, subject to withholding by the employer, while tips are reported to the IRS by the restaurant employees — or at least, they are supposed to be.

Titche said some restaurant owners have said they fear some staff will not want to work on large tables after Jan. 1, “because their W2 is going to include that tip, where under the old situation, I’m sure that some of the tip income is probably not properly reported. I think it’s part of that tax gap that we read about every once in a while.”

He said wait staff are supposed to report their tips to their employers at the end of each month, who then calculate the withholding and make the adjustment on their next payroll checks.

There was a practical reason for restaurants to come up with the automatic gratuity for large groups. Titche said a large group with a tab of $1,000 would be expected to pay a 15 percent tip of $150 if they got good service, but the customer “might only tip $100 because a hundred bucks seems like a lot of money.”

He said servers often feel they are cheated on large tables, but that may reflect the difficulty many customers have with figuring percentages. “A lot of people can’t do the math, which is really the sorry part,” he said.

Titche said many restaurant chains, such as Darden (Olive Garden, LongHorn Steakhouse and Red Lobster) are going to try a new system in which they suggest tips of 15, 18 and 20 percent and every customer’s bill, regardless of its amount, will show how much each percentage equals in dollars.

Restaurant chain owner Jeff Lobdell of Grand Rapids said many restaurants and banquet facilities started adding an “automatic gratuity” on large tabs years ago, but not all restaurants do that.

“I’ve never done that in any of my restaurants. We’ve always made a tip voluntary; it’s never been mandatory,” said Lobdell, a principal in Restaurant Partners. His company owns 17 restaurants and food service businesses from Traverse City to Kalamazoo, including Sundance Grill and Beltline Bar Mexican Café in Grand Rapids.

“For banquets, we’ve done a suggested tip, and I think the industry is going to follow suit,” he added. For large groups, his restaurants provide the customer with suggested tip amounts calculated at 15, 18 and 20 percent.

Lobdell, 46, has worked in the restaurant industry since he was a teenager. He serves on the Michigan Restaurant Association board of directors and was just elected to a three-year term on the board of the National Restaurant Association starting in January.

He said the industry is frustrated by what he calls “government meddling.”

“I don’t understand the reason that the government needs to meddle in the restaurant industry to the extent that they do. We are just small business people trying to provide jobs and help the families” of the employees, he said.

“Why they want to make the business more difficult for us to operate, and servers to work in this industry, is beyond us,” he said.

Justin Winslow, vice president of government affairs at the Michigan Restaurant Association, said the organization has been “reaching out to members the past couple of months on this topic, educating them on the transition coming. There will also be an article in our upcoming December Michigan Restaurateur magazine about the change.”

“It isn’t really new as a policy concept, however, since the 2012 ruling was an update and clarification of an earlier rule,” he said. “We just want to make sure those few restaurateurs that have yet to adjust their service charge policies fully understand the tax liability ramifications at play come Jan. 1.”

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