If you are a restaurant that charges a mandatory 18% service charge on large parties…or if you charge a mandatory $15 corkage fee for opening a customer’s bottle of wine…or a $3 per slice fee for cutting a customer’s birthday cake…you may want to reconsider this practice.
Why? Because starting on January 1, 2014, IRS Revenue Ruling 2012-18 takes effect. This ruling states that any mandatory “service charge” that is charged to a customer and then distributed to an employee will be considered part of the employee’s wage (and not as a tip). This has several important consequences:
1. As a “wage” and not a tip, this payment must be included in the employee’s base rate of pay for purposes of determining overtime compensation. This means that overtime pay will go up for these employees.
2. As a “wage” and not a tip, this payment will be subject to federal payroll and income taxes. Not only will you have to report this as income and then make proper payroll and income tax withholdings from the employee, but you will also have to pay the employer’s share of payroll tax (about 8%) on this amount too.
3. Any business who fails to pay these “wages” in full to any employee will be subject to serious and costly claims under the California Labor Code for failure to pay wages. Employees who successfully bring these claims can recover the wages owed along with penalties, interest, and attorneys’ fees. So even a tiny mistake can potentially lead to a huge liability.
As a result of this new IRS tip rule, many restaurants, hotels, bars, and catering companies have chosen to eliminate all mandatory service charges entirely. It is too risky, too costly, and too administratively burdensome for these businesses to continue trying to collect this revenue.
Have you reviewed your POS system, menus, guest checks, catering contracts, and other documents to see if your business imposes any type of mandatory service charge? If not, you should do so. You should also contact your employment law counsel to get competent advice on whether and how you might be able to continue collecting these charges without violating the law.