Why You Might Want to Rethink Auto-Gratuities for Groups

It’s a common practice at most restaurants: For parties of six or more, an automatic gratuity equivalent to the server’s anticipated tip (generally 18 to 20 percent) is often placed on the group’s bill.

As a restaurant owner, this provides a way for you to ensure that your server doesn’t get stiffed out of a big share of her potential profits for the evening if the party doesn’t tip well, since large tables are likely to require a lot of time and attention. Unfortunately, thanks to a new IRS policy, enforcing automatic gratuities may no longer be a good policy for restaurants to practice.

The new IRS rule, which goes into effect in January 2014, stipulates that automatic gratuities will no longer be considered as tips, but will be treated as service wages.

That means that, rather than taking responsibility for reporting these earnings along with other tips, as servers have in the past, the money will be considered part of the servers’ paychecks. Accordingly, the funds will be withheld until the server receives the paycheck, and the money will be subject to payroll tax. That means more bookkeeping hassle for restaurant owners, and potentially, less money in pocket for servers.

How can you avoid having your servers’ gratuities counted as service charges? According to the IRS, the money needs to pass four tests:

  1. The payment must be made free from compulsion.
  2. The customer must have the unrestricted right to determine the amount.
  3. The payment should not be the subject of negotiation or dictated by the employer policy.
  4. Generally, the customer has the right to determine who receives the payment.

That means that it is acceptable to print receipts that list the calculated total for several tip amounts (i.e., 18, 20, and 25 percent), but it is not permissible to automatically add the “tip” to the bill, or it falls in the service wage category, because the government believes that the amount has been dictated by the establishment.

Many chain restaurants, such as Olive Garden, that previously had auto-gratuity policies have ended the practice in advance of the new ruling and switched to “suggested tips.” If you don’t want to deal with the hassle of new paperwork, you might want to consider doing the same.

Servers are likely to be hit hardest by the new ruling, so if you get rid of auto-gratuities, consider raising your hourly wage to compensate for the tip money they might be losing.