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When is a tip not a tip? by Kelly O. Scott

Posted by admin on August 2nd, 2016

Categories : Uncategorised

Industry : Law

When it’s a service charge.  Revenue Ruling 2012-34 was issued by the Internal Revenue Service to provide 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 paid to employees are taxable as regular wages and not as tips.  Although the IRS initially delayed enforcement of Revenue Ruling 2012-34 to allow businesses time to make adjustments to comport with the new guidelines, the IRS now enforces the classification of service charges as taxable wages.

Accordingly, it is 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.

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Guest contributor is Kelly O. Scott of Ervin Cohen & Jessup LLP.

Kelly O. Scott, Esq. is a partner in the Litigation Department and is head of the firm’s Employment Law Department.  This publication is published by the law firm of Ervin Cohen & Jessup LLP. The publication is intended to present an overview of current legal trends; no article should be construed as representing advice on specific, individual legal matters, but rather as general commentary on the subject discussed. Your questions and comments are always welcome. Articles may be reprinted with permission. Copyright ©2016. All rights reserved. ECJ is a registered service mark of Ervin Cohen & Jessup LLP. For information concerning this or other publications of the firm, or to advise us of an address change, please send your request to hpadilla@ecjlaw.com or visit the firm’s website at ECJLaw.com

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