Automatic Gratuities: Restaurant gratuity, is it mandatory and legal?


Revel Blog | Revel Systems | November 11, 2021 |

Revel restaurant POS

A Guide to Automatic Gratuities 

We’ve all been to a restaurant where we enjoy a delicious meal and once the bill arrives, it’s slightly higher than expected. 

In the United States, it is customary and expected to provide a gratuity when enjoying a sit-down restaurant meal. It’s considered tacky and often cruel not to tip the waitstaff. 

Many restaurateurs have wondered whether they can use their restaurant POS platform to apply gratuities automatically. This can make life easier for customers, particularly when splitting the check among a large party.

Before implementing automatic gratuities, it’s important to be aware of the rules and regulations surrounding them. Let’s take a look at how an auto gratuity works and whether it’s a good idea for your restaurant.

What is an Automatic Gratuity?

A restaurant gratuity is not just a reward for a job well done; it’s a critical part of a server’s overall salary. Without gratuities, servers are unable to top up their wages and pay their bills. 

That’s why even if you feel that your server was rude or didn’t provide excellent service, you should always leave a tip. 

Auto gratuity features are available with modern POS platforms. Most restaurants will only apply the automatic gratuity fee to larger parties of six or more people. 

Some restaurants will do this without prior request and will state this policy on their menus, usually listed near the bottom of the menu.

The idea behind it is to avoid confusion, miscalculations and to ensure the server is adequately tipped. The standard gratuity fee for most restaurants is a flat 18%. 

Before implementing any gratuities rules, you need to understand the tax implications and the laws surrounding this type of service charge in restaurants.

Automatic Gratuity Laws

Firstly, is automatic gratuity legal? The answer is yes. Restaurants are free to implement an automatic restaurant gratuity without breaking the law. Traditionally, even automatic gratuities were classified as tips for tax purposes.

However, the IRS made changes to their guidance. As of January 2014, IRS auto gratuity law states that monies obtained through a mandatory gratuity system are no longer counted as tips, but as service charges.

What is the Difference Between a Gratuity and a Service Charge?

The IRS classifies a gratuity and a service charge differently. Whenever a server receives money via a service charge, it counts as part of their salary. On the other hand, tips are counted as separate income.

A mandatory gratuity counts as restaurant funds rather than the property of the server because the customer had no choice over whether to pay it. The restaurant itself can also choose to share or choose not to share monies gained via service charges.

The IRS provides clear guidance on whether a charge qualifies as a tip for tax purposes:

  • The customer must not be required to pay it

  • The customer must be able to decide on the amount

  • The amount cannot be decided via negotiation or restaurant policy

  • The customer decides who receives the payment

Unless these four provisions are met, any gratuities from customers will count as a service charge. 

Why does this matter? If a restaurant decides to levy automatic gratuities, the server is not receiving any tips in the eyes of the IRS. Restaurants operating this policy must then ensure that the server receives at least their state’s minimum wage.

Although many restaurants don’t pay minimum wage (as the server is expected to make up the difference in tips), if you implement an auto gratuity policy, you will be required to pay the state minimum wage.

This difference in designation means income earned through an automatic restaurant gratuity is reported and taxed differently from tips. Auto gratuities are reported as wages on annual payroll reports.

Can Restaurants Charge Automatic Gratuities?

With all this in mind, can restaurants charge gratuity fees automatically? Again, the answer is yes. 

At the federal level, nothing is stopping you from using your restaurant POS platform to charge restaurant patrons automatically. However, it’s important to note that state laws do vary.

No state explicitly makes it illegal, but there are differences in how it’s reported for tax purposes. Largely, most states follow federal guidance on automatic gratuity reporting. 

Before implementing this policy, take the time to look up the laws in your state. It’s always better to be safe than sorry!

Do Customers Have to Pay an Auto Gratuity?

Restaurants may be legally in the clear to charge gratuities in this manner, but do customers have any recourse not to pay them?

Back in 2013, a scandal emerged, whereby a Missouri pastor refused to pay an automatic gratuity applied to his Applebee’s bill. Unfortunately, the pastor broke the law as restaurants are free to charge, and customers are required to pay.

Due to the prevalence of U.S. tipping culture, most restaurants will charge a standard 16-18% mandatory gratuity. This practice enables customers who prefer to tip 20-25% to pay extra without upsetting customers who prefer to tip at a lower level.

Should You Charge Automatic Gratuities?

The general rule of thumb throughout the industry is to consult your staff before implementing this policy. Not every server wants to move to an automatic service charge in restaurants over traditional tipping models.

There’s no right or wrong answer when it comes to this issue. Work with your staff to discuss the pros and cons of implementing or not implementing this policy. 

Here’s what you need to know about the advantages and disadvantages of the mandatory gratuity system.

Pros

  • Simpler for the customer – Since there’s no need to work out the tip themselves, the automatic system takes the hassle out of figuring out percentages.

  • Easier bill splitting – Splitting the bill is much easier, especially with larger groups. A restaurant POS system can carry out this calculation and apportion gratuities automatically.

  • Restaurant Funds – Under auto gratuity law, monies acquired via automatic charges are service charges; therefore, they are the restaurant’s property. In this case, the restaurant owner decides what to do with the money.

Cons

  • Wage Requirement – In the eyes of the IRS, auto gratuities are not counted as tips; therefore, restaurants must pay the state minimum wage if they adopt this system. This may lead to the restaurant spending more funds on staff salaries.

  • Tip Reduction – Since the tip is already included, many customers may see no need to tip anything extra on top to bring it up to the standard 20%. Some restaurants may find overall tip amounts decrease under this policy.

  • Staff Opposition – Many restaurant servers prefer the traditional tipping system because the money they receive is their property under the law. Not all servers want their employer to have control over gratuity distributions.

Alternative Models to Tipping and Automatic Gratuities

A modern restaurant POS platform is more than capable of accommodating various tipping models. Here are some alternative models to the classic tipping system and the mandatory gratuity:

1. Tip Sharing

The federal government amended the Fair Labor Standards Act to accommodate tip sharing between tipped and non-tipped employees. The tip-sharing model enables chefs and other back-of-house staff to receive a portion of the tips gathered by servers.

Take note, some states, such as Massachusetts, explicitly prohibit tip sharing, so make sure you examine state law before considering this model. 

There are also seven states (mainly on the West Coast) that require restaurant owners to pay the minimum wage to servers before tips are taken into account regardless.

2. Service Charges

Rather than charging tips at all, some restaurants are now explicitly attaching service charges to bills. 

These range from 15% to 22% and are designed to provide the owner with complete control over the income. 

Under this model, the owner may distribute service charges in any way they want, but they must disclose these distributions.

3. Service Fees

The service fee model is basically the same as a service charge in restaurants. The difference is that service fees may be a smaller percentage of the bill. 

The reasoning behind the service fee model is to offset the costs of the experience in more highly regulated cities, especially on the West Coast.

4. Service-Included

Under the service-included model, restaurants build service charges and tips into their menu prices. Many overseas restaurants have utilized this model for years, especially in Australia and Japan, where tipping servers is an unorthodox practice. 

To make this model work, restaurants must charge enough on their menu to cover a living wage, health insurance, and other benefits.

While this model can work, it can also turn off customers. High menu prices may alienate customers, even if the overall cost of the model would be the same after tipping. 

Owners who want to consider the service-included model should research their local competitors to see if it can work for them. If restaurants are competing heavily on menu prices, this may make you less competitive.

Conclusion

Yes, you are free to charge gratuities automatically under U.S. federal and state laws. However, it’s crucial that you be aware of the tax implications in your area.

There is no “one size fits all” solution for dealing with tips and service charges. It largely depends on your customers, the local competition, and what the members of your staff want. 

When deciding on a model, it’s important to find a solution that satisfies both your staff and customers.

To accommodate your gratuity model, you need a restaurant POS platform to manage it. Get in touch with Revel Systems to learn more about our state-of-the-art restaurant POS terminals now.