Restaurants: IRS Ruling Regarding Tip Reporting

If you run a business where tips are issued for services rendered, there are some new rules to contend in the coming year. Due to a recent ruling regarding tip reporting, the Internal Revenue Service (IRS) is proposing changes to the way tips are reported, and more specifically, the taxes imposed on tips. Service industries, such as restaurants and others with tips received regularly, should be aware of the new reporting system and make appropriate adjustments.

New Tip Reporting Guidelines

The IRS has made some changes to the way you report tips and wages on your taxes, and the changes will go into effect during the 2013 tax season. The following shows the newest guidelines as issued by the IRS and outlined on its Internal Revenue Bulletin: 2012-26, and the four conditions that must be present in order for a customer payment to be classified as a tip:

  • Tips must be made free of compulsion
  • The customer must have the right to determine the amount
  • The amounts must not be subject to negotiation or employer policy
  • The customer has the right to decide who receives the payment


So what does this mean for your restaurant? Bottom line: It means you’ll have to start paying more attention to the difference between what is considered a tip and what is actually a taxable wage. The new changes focus on the distinction between what constitutes a “tip” versus a “service charge”.

Tips and Taxable Wages

Prior to the new ruling, restaurants and other service industries reported all tips on their tax forms, including those that may not be considered a taxable wage according to FICA.

However with the new IRS ruling, there will be a distinction between the two. If you have a restaurant that automatically adds a set predetermined percentage charge for customer bills or delivery fees — often listed as 18 percent gratuity — on the tip line on the receipt, and in turn the amount goes to restaurant employees, it is a considered a service charge according to the IRS. A mandatory service charges or mandatory gratuity under the new IRS ruling will be reported as taxable wages for FICA tax purposes.

On the other hand, making a note of a recommended tip with sample tip amounts but the area is left blank, that is still considered a tip and  not a taxable wage. This is because rather than being charged upfront, you are merely suggesting an amount and leaving it up to the customer to voluntarily choose what amount they will leave.

In situations where you aren’t sure if an amount should be reported as a taxable wage (service charge) or a tip, it should be considered a service charge for the most accurate tax filing, says the IRS. It’s also important to note than if an employee fails to report a tip to their superior, the company is not liable for this amount and does not have to file the amount as a taxable wage on their tax form.

For more information, consult the official IRS announcement and read through the IRS Q&A guidelines. You should also check with your tax attorney regarding the details and implications of the new tip reporting rules.