By: Renée Frojo, San Francisco Business Times
Ringing in the New Year on a bit of sour note, restaurants and hotels will have to start picking up the tab for employee tips thanks to a new rule enforced by the Internal Revenue Service.
Effective Jan. 1, the IRS will classify automatic gratuities as service charges that are taxable as regular wages and subject to payroll tax withholding.
That means that 18 percent automatic gratuity charge added to your bill at the Olive Garden for your party of six could be a thing of the past, as restaurants will likely do away with the practice altogether since the charge would create more paperwork and added costs for doing business.
Today, automatic gratuity added on bills is considered as a tip for servers, and it’s up to them to report it as income. The practice is usually done to ensure servers working large tables at a restaurant or working at high-end restaurants with big check averages get properly compensated.
While the rule technically went into effect in June 2012, the IRS postponed enforcement until January 2014 as a grace period to give restaurateurs enough time to adjust and properly comply.
The new regulations seem like a win for diners, as they will not be forced to pay what the business wants them to pay in terms of gratuity quite so often.
But for the restaurant employers and employees, the new rule is nothing but a headache.
“For employers, payroll taxes will go up because the server’s wages will go up,” said Jordan Bernstein of Michelman & Robinson, LLP, who works with a number of hospitality clients. “On the employee side, they will have to wait two weeks to get that money because it’ll be added to their paychecks — and as we all know, most servers are living day to day on those tips.”
Moreover, the rule could also make restaurants, “easy pray for class action attorneys that want to go after employee wage claims,” Bernstein said.
The likely biggest losers with this new regulation are the servers themselves, since restaurants may forego extra paperwork by eliminating automatic gratuity. That means waiters and waitresses could get snubbed by bad tippers.
One possible solution to help employees would be to place a suggested tipping amount on the menu, Bernstein said. However, that’s only a suggestion that many people could choose not follow.
Another solution would be to eliminate the tipping system altogether and instead compensate staff by raising menu prices — something many in the industry have discussed but few have actually done.
Bernstein said restaurants should prepare for the new rule if they haven’t already, as the state has been keeping a close eye on employee wage violations.
“As a business owner, you’ll definitely want to comply with this because it could lead to lawsuits very easily,” he said. “It only takes one employee to tell one class action attorney.”
Renée Frojo covers hospitality, restaurants, retail and nonprofits for the San Francisco Business Times.