New IRS Tipping Rules Took Effect January 1, 2014
New IRS tipping rules took effect on January 1, 2014 that now requires employers in the hospitality industry who apply automatic gratuities to some of their customers’ bills to treat those gratuities as service charges as opposed to tips. Auto-gratuities were first introduced into the service industry to protect employees, who often receive hourly wages well under minimum wage and rely on tips, from being “stiffed” by large parties. The new IRS rule will have a significant negative impact on both the hospitality employers and their employees.
For hospitality employers, this change will mean that they now have to track all service charge wages, withhold them as wages and report them to the IRS. Previously, when these amounts were considered tips, employers were only required to report them to the extent they were reported by the server. With the new change, employers will be required to factor these amounts into hourly wages and not only will this create more paperwork for employers with regard to bookkeeping and accounting, but it will also impact the amount that is due to servers for overtime work. Should an employer in the hospitality industry choose to continue the practice of applying automatic gratuity, they should review their recordkeeping and reporting practices and wage calculations in light of the new law as failure to comply with the rule may subject these employers to increased scrutiny by the IRS. However, what is more likely is that these hospitality employers will discontinue the application of automatic gratuities to parties because of the work involved in maintaining the practice.
Although ridding the service industry of automatic gratuities would be a hit to servers who can currently wait on larger parties with the security that they will be compensated for their time, it doesn’t appear that maintaining auto-gratuities under the new system would be any better for their situation. Reclassifying auto-gratuities as service charges would prevent servers from taking home the earnings on the same day. Instead, servers would not see these “wages” until they receive their paychecks. Such a result is a big consequence to a group of workers who have learned to budget knowing that they will be paid on a daily basis.
However, what seems to be missing from the conversation, and what many servers may not know, is that their employer is required to make up the difference between what the servers are paid and minimum wage when their tips fall short. In Michigan, servers can be paid as little as $2.63 per hour. However, if they do not make enough in tips to equal $7.40 per hour (or Michigan’s minimum wage), the employer is required to make up this difference. Therefore, if restaurants choose to remove the automatic gratuity from these larger parties and the server is not tipped at a level that would equate to minimum wage, then the employer must make up the difference. However, server wages regularly exceed minimum wage so this is not typically an issue. On the other hand, the prospect that servers would only be paid minimum wage feeds the larger argument of whether $7.40 per hour is a livable wage or even fair compensation for the job that servers do. Regardless of how one feels about the current minimum wage laws, the new IRS law could be seen as stifling a practice that the hospitality industry put in place to protect servers from having to live on the meager pay of minimum wage.
Lisa Okasinski is a licensed attorney in the state of California. If you have any questions, please contact the attorneys at Demorest Law Firm, PLLC.
