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A waiter serves patrons at Tony's Restaurant, part of the Casablanca Hotel in New York's Times Square. The custom at some restaurants of automatic gratuities for larger parties might change because of an IRS rule change. (AFP/Getty Images)

IRS To Count Automatic Gratuities As Wages, Not Tips

Sep 5, 2013

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Gratuity included? A new IRS rule could end, or at least curtail, the practice.

The Internal Revenue Service will soon begin classifying automatic gratuities as service charges that are taxable as regular wages and subject to payroll tax withholding. Currently, they're considered tips, and it's up to the wait staff to report them as income.

The Wall Street Journal says:

"The change would mean more paperwork and added costs for the restaurants—and a potential financial hit for waiters and waitresses who live on their tips but don't always report them fully."

The original rule technically went into effect in June 2012, but the IRS pushed back enforcement until January 2014 to allow restaurants time to comply. The rule change stipulates that a tip is defined as something given without compulsion and that a customer must have an "unrestricted right to determine the amount," according to the California Restaurant Association's website.

So, those 18 percent automatic gratuities for large parties that are common in many restaurants, such as the Darden chain-owned Olive Garden, LongHorn Steakhouse and Red Lobster, would be treated as a service charge for tax purposes.

As of July, Darden has already stopped the automatic tips at 100 restaurants in four cities, "where it is testing a new system in which [they] include three suggested tip amounts, calculating for the customer the total tip with a 15%, 18% or 20% tip on all bills, regardless of party size," the Journal says.

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