As of January 1, the Internal Revenue Service (IRS) will classify automatic gratuities as non-tip wages that are subject to tax withholdings. Because of this ruling, restaurants are rethinking including automatic gratuities on certain bills – or seeking easier ways to document wages and calculate payroll.

As per the IRS’ Topic 761 (Withholding and Reporting), service charges added to a bill by the employer that the customer must pay – often called automatic gratuities – will constitute non-tip wages. These include large party charges, bottle service charges and mandated delivery charges. Non-tip wages are subject to social security tax, Medicare tax and federal income tax withholding. Therefore, restaurants cannot use automatic gratuities when computing the credit available to their employees.

What this means for your restaurant

Payroll: Using automatic gratuities makes more work for restaurant managers, as it complicates payroll calculations. Restaurants that use these “non-tip wages” will be required to adjust the gross salary earned during each pay period to include these automatic gratuities.

Taxes: And as employee wages increase – as a result of adjusted gross salaries – their taxes increase as does their employers’ tax liability. Employees who receive a large amount of automatic gratuities will have higher social security contributions, for example. Employees are likely to be unhappy about this.

Satisfaction: Automatic gratuities can cause problems for both customers and employees, making them dissatisfied with their experience or job. Customers may not find it fair that they have to pay an added amount on their bill, especially if the service did not meet their expectations. And employees could be frustrated with the fact that they have to wait until their next paycheck to collect their earnings.

How to keep in compliance

There are a two ways to remain compliant with IRS standards:

1. Stop charging automatic gratuities of any kind.
2. Automatically include automatic gratuities in payroll calculations using an advanced restaurant POS system.

These two solutions can solve the problem without wasting additional time or money on payroll or reporting. Tracking “non-tip” wages manually is not an option for smart restaurants, as it will decrease productivity and increase unnecessary costs.

Bonus tip: Restaurant receipts can include suggested tip amounts (15% or 20% of the total bill) to motivate customers to leave a desirable amount, rather than demanding it.

Whichever you choose, communicate these changes with your restaurant staff. Make sure they understand that the restaurant is enforcing these changes to keep in compliance with the IRS and not to effect employee pay.