Yes, in nearly every state there are cases in which a restaurant can, and should, charge tax on a gratuity. In terms of sales tax law, whether or not the gratuity should be taxed depends on how gratuities are split among employees, and how the gratuity is charged to the customer. Generally, if the gratuity is paid voluntarily it is like a gift, and non-taxable; but if it is mandatory, it is like an additional charge from the business, and so is taxable. Laws vary some from state to state.
Restaurants must also charge employees income tax on their gratuity income. It’s legal income, and considered part of their wages for services rendered.
The minimum wage for servers is significantly lower than standard minimum wage, and restaurants must prove that their servers are earning at least minimum wage, or make up the difference in pay. In order to prove that they are meeting that obligation, they should track gratuity-related wages, and tax them accordingly. Servers cannot, however, be taxed on income that they are not allowed to keep.
What is the difference between a tip and a service charge?
Tips and service charges are considered two different classes of gratuity, and one is typically taxed while the other is not.
A service charge is a gratuity payment that is forced upon a customer. For example, if a party larger than 10 is automatically charged an 18% gratuity, this is considered a service fee and it should be taxed. This can be quite expensive if a restaurant caters to a large party. One businesswoman cited a $12,000 catering bill from a restaurant that had a 20% mandatory gratuity of more $2,000 dollars, resulting in more than $40 dollars of additional sales tax.
Service charges are typically published somewhere on the menu, and are automatically added to the bill. There is no opportunity for guests to deny the charge, and no discussion over how much it will be. Often, a portion of the service charge is then passed on to the wait staff as a gratuity, while a part of it is retained by the restaurant to cover increased expenses related to serving a large party.
A tip is a gratuity payment that is paid voluntarily by the customer, for the wait staff’s services. If the guest sets the amount for the gratuity, either by paying it in cash or adding it to their tab after it is subtotaled for payment, it is considered a tip and should not be taxed.
Other tips that one might pay at a restaurant, which are not taxable, include payments to a coat clerk, valet, or parking attendant.
Can restaurants charge sales tax on gratuities?
Restaurants can charge sales tax on gratuities if the gratuities are not all going to the server. If the restaurant keeps back any of the gratuities, then all of the gratuity must be taxed as a service charge.
To determine whether or not a gratuity should be taxed ask the following questions: Who does this money belong to; how is the gratuity identified on the bill; and will the whole gratuity be given to members of the wait staff as a financial reward for services rendered.
If the answer to any of those questions is “no” then the gratuity should be taxed as a service charge. Both a service charge and a tip can be charged on the same bill, so that only part of the total gratuity is taxed.
Can restaurants charge income tax on gratuities?
Yes, as part of an employee’s wages, both state and federal taxes should be taken out of a server’s check against their tip income. This includes basic state and federal taxes, Social Security payments, and Medicare and Medicaid taxes.
A server should not, however, be taxed against all of their tip income unless they are allowed to keep all the tips they receive. Typically, a certain percentage of the tips goes into a tip pool, to be divided between other service people who do not receive tips. This includes bus boys, hosts or hostesses, bartenders who send drinks out on the restaurant floor, and others.
Owners and managers cannot receive funds from the tip pool, and servers can be required to place no more than 50% of their tips into the pool. Typically, servers are allowed to keep, and should be taxed on, 65% of their total received tips.
The amount of tax that is charged on a server’s tips depends on their tax filing status, the number of dependents they claim, and other filing information. If too much money is removed for taxes, that overage will be identified at the end of the tax year and returned to the server in the form of a tax refund. Tax refunds can be received from the federal and state governments.