The new rule proposed by the Internal Revenue Service (“IRS”) seeks to classify automatic gratuities as service charges, and treat them as regular wages because they are not voluntary. With this new change, automatic gratuities collected would be subject to payroll tax withholding rather than being treated as tips, as it was customarily calculated in the past.
Restaurants such as Olive Garden, Red Lobster, and LogHorn Steakhouse have been known to include an automatic gratuity of 18% for parties of eight or more individuals. However, Darden Restaurants Inc. which owns these restaurant chains is now experimenting by eliminating the automatic gratuity altogether because of this new IRS rule.
Customarily, restaurants would report automatic gratuities as tips, which granted the employees the discretion to report the tips as income. The new IRS rule may likely influence restaurants from continuing the practice of adding automatic gratuities to the tabs of large parties as it would create more paperwork, increased costs, and a financial burden for restaurant employees.
The IRS has announced that it will begin classifying the automatic gratuities as service charges beginning in January 2014. Restaurants are required to report the tips to the IRS, and are responsible for paying Social Security and Medicare taxes on the amounts reported.