Tips Versus Service Charges: What’s The Difference?


Posted by: Brookside Admin

Everyone has seen, or been a part of, the larger groups at restaurants that involved more than 10 people. Usually, these are parties, conventions, or other large gatherings and take up a lot of space. Just about every restaurant has a rule that they will add a certain percentage (usually 15-18%) to a large party’s check. Most of us assume that this service charge is actually the tip going to the server(s) who served those at the party, but this has not always been the case.

Tipped employees have long been fighting with the “service charge” concept and there have been conflicting rules among employers when it came to paying tipped employees out of this charge. While some employers passed this fee on to the server as their tip, others kept the service charge fee and the employee usually did not receive anything for serving the party. So, the IRS finally decided that there needed to be set guidelines that helped to distinguish between “tips” and “service charges” to clear this up once and for all.

In 2012, the IRS issued Rev. Rul. 2012-18, which lays out specific rules to determine what makes a tip and what makes a service charge. According to the IRS, to determine if a payment is a service charge or a tip, you have to look at these factors:

“The payment must be free from compulsion.”
“The customer must be able to determine the amount of the payment without restriction.”
“The payment cannot be negotiable or dictated by the employer.”
“The customer should generally have the right to decide who receives the payment.”

If any of these areas are missing from the equation, then the IRS states that “there is doubt that the payment is a tip.” So does this mean that all service charges are not tips? No, the IRS puts forth a clarifying distinction in the following example: “A restaurant policy of automatically adding an 18% charge to the bill of parties of six or more is a service charge, whereas a bill with sample calculations of different tip amounts (e.g., 15%, 18%, or 20%), where the actual tip line is left blank, is a tip.”

If you are concerned that you have been the victim of tip theft due to how your employer classified service charges, read our Employment Law page for more information or contact our office to have your case evaluated for free (918) 582 – 2500.

Other great articles on our site:

Can Your Employer Take Your Tips?

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