Automatic Tipping: Irs Rules Change Could Be Taxing For Hospitality Industry

By Annalisa Rodriguez, The Indianapolis Star

McClatchy-Tribune Information Services

Oct. 11--When Thomas Howard sees an automatic gratuity on a restaurant bill, one thing is for certain: His server won't be getting any more than that amount.

If restaurants tack on the charge to his bill, the Indianapolis resident said he doesn't think servers should expect any more. But when it comes to leaving less, he thinks that's not even allowed.

"I don't think you can, can you?" Howard said. "You've got to go by whatever their policy is."

He's confused -- and a little put off -- by the whole "automatic gratuity" practice, and he's not alone.

Even with automatic tipping, customers have always faced a decision over how much to leave a server. Now, thanks to an IRS ruling, restaurants are being thrown into the debate -- and are faced with a decision of their own: Should tipping for large parties be left solely to the customer or should the restaurant tack it on to the bill?

The new IRS ruling that takes effect in January will treat automatic gratuities as service charges, rather than tips. The switch means servers will no longer be responsible for reporting those automatic tips as income. And it also means automatic gratuities will be considered a part of a server's wages, making that money subject to payroll tax withholding and delaying receipt of those automatic tips until an employee's next paycheck.

Understandably, many servers aren't happy about the tax policy, but neither are restaurant owners. The IRS change will create additional accounting and bookkeeping work for restaurants, because automatic gratuities will have to be factored into hourly pay rates that could vary depending on the number of large parties served by the employee.

"Some may be equipped to deal with that additional accounting," said Patrick Tamm, president and CEO of the Indiana Restaurant and Lodging Association. "Some may not."

The IRS policy change could also mean the loss of an income tax credit, which restaurants receive for paying Medicare and Social Security taxes on employees' reported tips. Service charges are not eligible for the credit. Industry officials say the change could have a great impact on Indiana, where restaurants are projected to register $9.2 billion in sales in 2013. Restaurants account for 296,100 jobs in the state -- 10 percent of the work force.

"It's a big deal because it impacts in one way or another 10 percent of the work force in the state of Indiana," Tamm said. "Not all employees in restaurants are tipped employees, but they could still pay for it."

Restaurant hiring also could take a hit as a result of the IRS ruling, Tamm said.

"It could affect hiring if restaurants continue to be faced with additional costs and burdens to comply with government mandates and regulations," he said. "That cost has to be paid for in some fashion and it may be paid for by not hiring as many people as they would like."

Some dropping practice

Several restaurants are wondering whether the right course of action might be to eliminate automatic gratuities altogether.

The Melting Pot on Indianapolis' Northeastside no longer puts an 18 percent automatic gratuity for parties of six or more on checks, owner Bennet Ackerman said.

"It's going to hurt us as employers, because now I'd be paying taxes on that as a wage which in the past I haven't," Ackerman said. "Between that and the health-care reform, it's adding one more burden to employers."

Still, it's a change he is not completely opposed to.

"I think some servers tend to get a little lazy when they know they already have that automatic gratuity," Ackerman said.

After The Melting Pot stopped automatic gratuities, server Michael Turney noticed a decrease in the amount of tips he received.

"I feel like larger parties don't tip as well as they should for the amount that they spend at the restaurant," said Turney, who has been a server at The Melting Pot for two and a half years. "When they spend $200 and leave $20, you're losing out on about $16 or $17 when we already pay a tip out to a host, bartender and bussers. It really makes the income of a server go down."

The change also has made many servers reluctant to take on large parties of customers, Turney said.

"They don't feel like the time that they dedicate to a large party, which does take up a lot of time, is actually rewarded," he said. "They could make more money off smaller parties."

Darden -- which operates Red Lobster, Olive Garden, Longhorn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V's and Yard House -- is testing a new concept that eliminates 18 percent automatic gratuities for parties of eight or more and instead leaves tip percentage calculations at the end of a bill.

The restaurant group is experimenting with the tip suggestions in 100 restaurants in four markets across the country -- none in Indiana -- and will decide whether to keep the automatic grauity or do away with it at all locations by the end of the year.

"What we have seen so far is that guests appreciate the convenience factor," said Darden spokesman Rich Jeffers, "and our employees appreciate the fact that we're seeking to preserve those tips for them."

Cunningham Restaurant Group, which operates Bru Burger Bar, Mesh, Stone Creek Dining Company and other Indiana and Ohio restaurants, hasn't yet decided how it will handle transactions come Jan. 1.

The most challenging aspect, says chief operating officer Mike O'Donnell, is figuring out a way to pay employees different wages if automatic gratuities are kept.

"That's the tricky part," he said. "Logistically, it becomes a challenge for us."

O'Donnell said he will talk with other restaurant owners and see how they plan to handle the ruling.

"There's no real clear-cut direction on which way to go," he said. "Either way, there's some rewards and some risks."

Industry experts say the ruling was updated because of a concern that automatic gratuities have become charges that feel compulsory to customers, when they are supposed to be voluntary.

Indianapolis resident Summer Jones likely would agree. She believes servers sometimes don't deserve the automatic gratuity that she sees as compulsory.

"I know I've encountered servers before that haven't been pleasant or attentive," she said. "But off of my party, they might get $40. It's a little disheartening."

Worries about coercion

"The IRS has signaled its intent to scrutinize auto gratuity patterns to determine whether they are tips or if there has been more coercion so it becomes more of a service charge," said Marianna Dyson, a Washington, D.C.-based lawyer who represents restaurant chains.

Industry experts say the ruling may also be a way for the IRS to combat the fact that many servers do not fully report their tips.

"I don't think we can always assume it's a perfect system and every dollar that is being tipped is being reported," said Judith Hack, an associate professor of hospitality and tourism management at Purdue University-Calumet. "Maybe this is the first in a series of tightening up."

Servers, who make $2.13 an hour in Indiana, are likely to be the most affected by the change, experts say. Rather than receiving automatic gratuities at the end of the night, under the new IRS rule those payments would be tacked onto paychecks as wages. That could adversely impact servers who have come to depend on that extra cash at the end of each shift.

But, on the flip side, it could also mean fewer headaches and less anxiety when it comes time to file taxes. Some servers also prefer receiving tips on their paychecks because it makes budgeting -- and saving -- easier.

For some servers, automatic gratuities provided a layer of protection against customers who might not have been so generous with their wallets without the practice.

As workers in the restaurant service industry try to make sense of the effects of the ruling, Dyson, the attorney for restaurant chains, said the IRS needs to create clearer guidelines to erase the confusion that exists now.

"How far can a restaurant go to suggest an appropriate tip amount, before it is converted to a service charge?" she said. "What does a check need to say? How do you have the discussion with the guests? That's where I think the next frontier is with the IRS, having those discussions."

What was your best tip ever?

We asked several servers for their best tipping tales.

-- Michael Turney, a server at The Melting Pot, remembers last Valentine's Day when he thinks of his best tip. Turney received $100 on a $160 bill from two couples that were on a double date and ordered a five-course meal.

-- Jewele Edwards, manager of the Front Page Sports Bar & Grill, can't recall an exceptional tip, but says she has a few regulars who make her breathe a sigh of relief when they walk in the door. She knows they will tip her $40, but she is also glad for the opportunity to catch up with them.

-- Andre White, owner of the Panache Day Spa salon in Indianapolis, remembers a customer who tipped his masseuse $50 on an $80 bill. "It was kind of unexpected, and the lady was just really happy," White said, "and she was one of those people that just tip really well." Most people, however, are not that generous. "I think people try to save that money for something else," he said.

-- For Valerie Vincent, a hair stylist at A Do Hair Design, last Christmas brought an extra surprise. An eight-year client unexpectedly gave her $100. "It made me cry because I had been out of work for six weeks (with a broken arm), so it was very much appreciated," she said.

-- Tattoo artist Anthony Wheeler once completed a tattoo on a woman who thought her Disney character was going to cost a lot more than $70. She tipped him $210. Wheeler said people might not realize that tattoo artists only take home a portion of what a design costs and buy their own supplies. From a $100 tattoo, he might see about $35. A tattoo artist since 1996, he has seen tips become less and less generous. Back then, he might get $100 in tips in an eight-hour day. Now, he's lucky to get $30. "With the way the economy is, a lot of people don't have the extra money for a tattoo to begin with," he said. And big tips are rare, especially in a challenging economy. "It's a luxury item," Wheeler said. "Whatever extra money they have, they keep."

___

(c)2013 The Indianapolis Star

Visit The Indianapolis Star at www.IndyStar.com

Distributed by MCT Information Services

Wordcount:

1794