Hospitality industry employers sometimes add an automatic gratuity to the customer’s bill, especially for large customer groups, e.g., automatic 15% to 20% for a party of six or more customers. Beginning January 2014, automatic gratuities are not classified as "tips," but as service charges reportable as the employee’s regular wages, which are subject to payroll tax withholdings, according to IRS rule, Rev. Rul. 2012-18.
To be classified as a "tip" under IRS rules, four criteria must be satisfied:
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The payment must be made free from compulsion.
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The customer must have the unrestricted right to determine the amount.
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The payment should not be the subject of negotiation or dictated by the employer policy.
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Generally, the customer has the right to determine who receives the payment.
Accordingly, automatic gratuities should not be classified as tips for FICA payroll purposes. If any portion of an automatic gratuity is distributed to an employee, it is classified as a service charge and wages for FICA tax purposes. We will continue to monitor this ruling.
