When it’s a service charge. On June 25, 2012, the Internal Revenue Service (IRS) issued Revenue Ruling 2012-34 which provides guidance to employers and employees on the difference between tips and service charges as well as on certain reporting requirements. The ruling states, among other things, that service charges are taxable as regular wages and not as tips. Although the IRS delayed enforcement of Revenue Ruling 2012-34 to allow businesses time to make adjustments to comport with the new guidelines, the IRS will begin enforcement of classifying service charges as taxable wages this year.
Accordingly, it is now essential that every employer understand the difference between tips and service charges. The distinction is important as it impacts the employer as well as the employer’s customers and employees. Unlike a tip, a required service charge is subject to a sales tax which must be collected from the customer and remitted by the employer to the taxing authority. As service charges are considered wages, they are subject to all standard wage withholding and reporting requirements. Further, such charges must be included in determining each employee’s base rate of pay for calculating overtime.
Unlike a mandatory service charge, a tip is free from compulsion. More specifically, although suggestions are not prohibited, the customer must be able to determine the amount of the payment without restriction. Finally, the customer should have the right to decide who receives the payment. If the standards for a tip are not met, the payment will likely be considered a service charge. Service charges are typically defined as non-negotiable or “standard” fees charged by an employer in connection with such services as room service, large party service, delivery service and bottle service.