How the IRS Tipping Crackdown Impacts Restaurants, Servers

Many restaurant owners say the new IRS crackdown on automatic gratuities is pushing them to ditch their policies for large parties – unwelcome news to servers across the country.

Beginning this month, the IRS is cracking down on how restaurant owners pay out automatic tips – i.e. the typical 18% charged for parties of 6 or more. Going forward, these tips must be classified as service charges that are taxable as regular wages and subject to payroll tax withholding (aka more paperwork), rather than pooled into the tip cash servers divide at the end of their shift (which has been common practice until now).

Though the policy isn’t a new one, having been issued in June 2012, the implementation was delayed until 2014 to give restaurants time to comply. And rather than deal with the paperwork involved, some restaurateurs are choosing to ditch the mandatory tip altogether.

“I’ve counseled all of my [restaurant] clients nationally to get rid of auto-gratuity based on table size,” says Carolyn Richmond, co-chair of law firm Fox Rothschild’s hospitality practice. Richmond says incorrect handling of auto-gratuities could jeopardize restaurant owners’ ability to take the tip credit, which allows owners to pay their tipped staff less than the minimum wage. For instance, in New York, tipped servers can be paid just $5 an hour -- $3 less than the state’s minimum wage.

Owner Confusion and Server Frustration

The Tax Foundation, a non-partisan tax research group based in Washington, D.C., says the clarification of the rules regarding auto-gratuities are just the latest in the IRS’s effort to crack down on unreported tip income.

“To the IRS, it’s just a clarification ‘in the best interest of tax administration.’  But one that will make life a little bit harder for restaurants and their waitstaff,” writes Tax Foundation expert Joe Henchman.

While National Restaurant Association spokeswoman Liz Garner says the trade association has been working closely with the IRS to educate the industry, some restaurant owners seem to be perplexed by the policy.

“I don’t fully understand the letter of the law,” says restaurateur Sara Jenkins, who owns New York City restaurant Porsena and will continue to charge an auto-gratuity of 18% on tables of six or more.

Since the majority of her tables pay by credit or debit, Jenkins says they already process tips and pay them out at the end of each week. As a result, her accountant told her that they won’t have to ditch their auto-gratuity policy, because it’s already being correctly processed through Paychex.

Despite this, Jenkins says whether or not to ditch the auto-gratuity is an ongoing discussion with her waitstaff.

“They don’t want to add the auto-gratuity if they can get more, because the average tip is 20% to 22% sometimes,” says Jenkins.

But on the other hand, Jenkins says the policy is necessary when dealing with tourists whose countries’ tipping standards differ from those in the U.S.

“They tip 7% and it seems like a great tip to them,” says Jenkins.

One server in Times Square’s Aspen Social Club isn’t happy about the crackdown. The restaurant and lounge ditched its auto-gratuity policy last year – and she says tourists simply ignore the “suggested gratuity” amounts now printed at the bottom of each check.

“I’m upset. People that don’t live here that aren’t used to tipping don’t tip,” she says. Since the restaurant is located in the ground floor of a hotel, the server says all of the customers for breakfast are tourists, and many of them are traveling internationally.

“It depends on the day, but it’s a lot of money,” she says.