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During 2012, the Internal Revenue Service issued a new ruling regarding the taxation of automatic gratuities included on the tabs of restaurant guests. The ruling is effective January 2014 and will require automatic gratuities to be classified as service charges, which are treated as regular wages by the IRS. This means the automatic tips are subject to payroll tax withholding. With this new ruling, many restaurants are experimenting with other ways of automatically charging gratuities and many are dropping the practice all together.

It is common practice for restaurants to include an automatic tip of a specified percentage to the bill of large parties to help ensure their servers are not short changed on large tabs. With the new ruling, restaurants will need to factor automatic gratuities into pay and begin withholding Federal and State taxes on the wages. This change will result in increased paperwork and administrative expenses for restaurants, in addition to various financial consequences for wait staff. Some restaurants are starting to include suggested gratuity on tabs, instead of automatically adding it into the bill, to avoid the new tax consequences. This practice still allows the customer to decide on the final tip and, therefore, has not been deemed a service charge by the IRS.

With the increased costs of healthcare reform and other items on the horizon, this is another issue to be considered by restaurants when planning for the upcoming 2014 tax year.

For more information or questions on this topic, please contact your local UHY LLP professional.