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What you should know about Auto Gratuities as Wages

History

In 2012 the IRS released a bulletin (Revenue Ruling 2012-18) clarifying the classification of auto gratuities and service charges for income tax purposes. The bulletin indicates that automatic/mandatory gratuities are considered service charges and therefore wages as opposed to tips. The IRS stated these changes would go into effect as of January 1, 2013 and then later they moved the date to January 1, 2014.

Amounts left by customers must meet all of the following criteria to be considered a tip (this is what makes a mandatory gratuity wages as opposed to tips):

(1) The payment must be made free from compulsion;

(2) The customer must have the unrestricted right to determine the amount;

(3) The payment should not be the subject of negotiation or dictated by employer policy; and

(4) Generally, the customer has the right to determine who receives the payment.

What does this mean?

While there are several things to be aware of regarding this rule change but know that the effects are mostly administrative. The IRS taxes personal income for wages and tips almost identically. The change will mostly impact payroll taxes and certain tax credits. Here is a general list of items that will be affected by Revenue Ruling 2012-18:

 FICA Tip Credit - Amounts classified as wages by the IRS are not eligible for the FICA tip credit (forms 8846 and 3800) which gives employers a general end of the year credit on SS and Medicare taxes paid on tips in excess of the federal minimum wage. Rev. Rule 2012-18 will take a bit of this credit off the table. Do not confuse this with the “tip credit” taken against minimum wage standards for tipped employees. These are two different rules with similar names.

May 11, 2018 www.restacct.net  Reporting – Wages and tips are reported on separate lines of the quarterly payroll tax return (lines 5a and 5b). While the same rate applies to these items, it is important to report the wages/tips on the correct line for end of the year credits and reporting (such as the credit mentioned above).

 More Reporting - The tip income informational return (form 8027) should not include mandatory gratuities as this form is only for the allocation of tip income.

 Overtime – As mandatory gratuities are considered wages, these amounts should be factored in to any overtime pay. This can get confusing because if an employee works a 40 hour week with mandatory gratuities then that amount counts towards the weeks hourly wages. Check out the example:

Sammy Server makes $8.00/hour and has worked 40 hours so far this week. Sammy has also received $120 in mandatory gratuities for the week. This means Sammy’s total wages for the 40 hours worked are $440. Sammy is a good employee and has picked up some extra shifts for this week from Sally Slacker, another employee. When figuring Sammy’s overtime rate you must include the mandatory gratuities in the hourly rate. So for the first 40 hours Sammy was paid at a rate of $11 (440/40), instead of the original $8 rate. This means Sammy’s overtime rate will be $16.50/hour instead of the more intuitive $12/hour. Remember also that any mandatory gratuities earned during the overtime hours can go towards the overtime rate.

 State Implications – Many states allow employers to pay tipped employees a lower wage as long as the amounts of the tips increase the total rate to the minimum wage. Remember though that mandatory gratuities will count toward the hourly wages paid and not towards tips received by the employee, as stated above.

What do I need to do?

There is now an argument that can be made for the elimination of mandatory gratuities, and given some of the reporting issues it may be time to reevaluate the benefits of mandatory gratuities versus the changes that must be made regarding this rule. Here are some of the changes that you must make as an employer (Beware this list is not meant to be exhaustive as there are many types of payroll/sales systems that may require additional action):

 Use the auto gratuity worksheet provided located in the Virtual File Cabinet to track your auto gratuities earned during the pay period. Also, remember to manually track employee rates and hours for overtime as a result of auto gratuity wages.

 Ensure that your point of sale system (or wherever your payroll/sales lives) has the ability to separate mandatory gratuities from other tips and can report them properly. Even a separate line on the paycheck to indicate these amounts were paid to the

1101 West Mineral Avenue | Littleton, CO 80120 | Tel. 303-458-1204 | Fax 303-458-1565

employee will allow for proper reporting. This is the main change that must be made as it will help RSI (or any payroll provider) report your wages paid properly and will allow your CPA to take the appropriate end of the year credits regarding employee tips.

 Make certain that your employees are being paid the appropriate overtime wages (if applicable) and that your system is able to account for mandatory gratuity income as part of an hourly wage.

 Finally, always make sure that your payroll provider and CPA are aware of these changes and are reporting mandatory gratuities paid to your employees correctly. As stated above, these changes are mostly administrative and would not likely create a new tax liability, but it is the policy of RSI to create best practices to lower the chance of audits and avoid any negative contact with state and federal regulatory agencies.

As always, if you have any questions about this or any tax issue, please contact Matt Wiseman at 303- 458-1204 ext. 272.

Sources

IRS Revenue Ruling 2012-18

IRS Announcement 2012-25

May 11, 2018 www.restacct.net