An automatic gratuity is a predefined tip, automatically added to the client’s bill or calculated into the service price, typically 15-20% of the service price.

In this post, I’ll go over the pros, cons, and different ways you can implement automatic gratuity if you choose to do so. I’ll also tell you about the new IRS regulations about how automatic-gratuities are to be classified.

Pros

Your professionals are guaranteed 15-20% of every service performed. 
If you are located in a touristy location, this policy eliminates the morale issues caused by stingy tourists who know they’re unlikely to ever return to the location and feel no remorse about stiffing their service provider.

Clients do not have to calculate the proper amount.
Every so often, you’ll come across a client that will have an internal battle while filling out their receipt. Several of them will outright ask. “What should I tip? Is 15% enough? Is 20% too much?” Auto-gratuity ends this guessing game once and for all.

You don’t have to worry about whether or not your employees are reporting their tips properly.
If an employee receives cash tips of $20 or more in a calendar month, they are required to report to you the total amount of tips they receive in writing by the 10th of the next month. You are responsible for paying the employer’s portion of social security and Medicare taxes and must collect the employee’s portion of the social security and Medicare taxes and their federal income taxes. (You can see why paying cash tips to employees and under-reporting would be appealing to both salon owners and staff.) If you’re collecting all tips when you collect payment, you will know exactly what your employees were tipped and will be able to tax them and report them appropriately.

Cons

Your professionals are guaranteed 15-20% of every service performed.
Yeah, the same thing that makes this a pro also makes it a con at times. Your employees know they’re getting tipped regardless. For some professionals, this may affect the way they perform their services. However, this point can be argued. You, as the salon owner, are ultimately responsible for ensuring your employees are performing to superior standards. If a professional slacks, you’re responsible for evaluating whether they need to seek employment elsewhere. If you’re managing your team properly, this con won’t be an issue.

Clients do not have a choice about the amount and may not appreciate the policy.
Some clients do not like being “forced” to pay gratuity.

Ways to Implement Auto-Gratuity

Clarify it on your brochures. “An 18% gratuity is automatically added to every bill.” I don’t particularly like this method. For one, this turns the service pricing into a lie. The prices aren’t accurately reflected on your brochures since a compulsory 18% charge is added at checkout. (I also calculate sales tax onto my retail items’ sticker price. Nobody likes to do percentages while shopping.)

Some clients may not see this fine print and will argue about it at checkout. This also makes it clear that gratuity is not negotiable, which gives some clients the distasteful impression of compulsory tipping.

Give clients the option to choose 15%, 18%, or 20% at checkout. While this method does give the customer freedom to choose which amount best reflects the service they’ve received, it leaves the door open for debate and will be difficult to implement when clients pay by cash or check.

Include the service fee in the service pricing and make it clear to the customers that your salon does not accept tips. This negates the client’s feeling of being forced to tip. For clients who insist on tipping, tell them, “We set our service prices appropriately to ensure that our staff are well-compensated. We appreciate the gesture, but we do not accept tips.”

Service Charges vs Gratuity

Recently, the IRS distinguished auto-gratuity from “tips.” They now consider auto-gratuity to be a “service charge,” which they consider non-tip wages. They’re still taxed the same way all tips are–they’re subjected to social security tax, Medicare tax, and federal income tax withholding–so nothing has changed. Only the terminology the IRS uses to classify that income has changed (for us, anyways–the food and beverage industry is the only one really affected by this change since the “service charges” cannot be applied to meet the 45B minimum wage requirement the way tips can–but that’s their problem…sorry restaurant people).

The IRS maintains the position that if the fixed cost is charged to the customer by the employer, the additional cost is not a tip, but wages.

To be considered a tip for tax, four factors must be satisfied:

• the tip must be made without compulsion,
• the customer determines the amount at their discretion,
• the tip is not the subject of negotiation or dictated by policy, and
• the customer determines which employee receives the tip.

Since an auto-gratuity is determined by the employer and mandatory, the auto-gratuity is considered a wage. It’s all semantics where we’re concerned. The IRS can call it whatever they want, but the new legislation changes nothing for our business.

If you want to implement service charges, I recommend that you calculate your service prices and compensation based on your total overhead, then tack on 15-20%. That service charge will go straight to your professionals (after taxes).

Personally, I have never liked the idea of being tipped.
We are not waiters, bellhops, or cab drivers. We aren’t entry-level, unskilled workers in minimum wage positions.

We’re educated professionals providing a service.

Our pricing should adequately account for our expenses, cover our salaries, and leave us with a little to put in the salon’s savings. We should not need to be rewarded for superior performance. Providing a great customer experience and doing the job we are being paid to do is expected of us without the silent possibility of additional income.

Additionally, I don’t like to gamble the financial welfare of my employees on the gratitude or generosity of others. Our salons charge what we charge because that’s what we need to pay our bills and keep our business open.

Minimum wage is going up in states all across the country. As an employer, you have FLSA regulations to adhere to.
Our business is very high-overhead. No longer can salon owners continue to push cost-of-doing-business expenses onto their professionals or expect customers to compensate their workers.

Never forget that this is a business. Do your math (like every other business) and make sure you’re doing better than breaking even.

The Salon Compensation and Pricing Megakit calculates salon compensation and service pricing for you! It includes:

• The Salon Compensation and Pricing Calculator, an 8-page spreadsheet system that makes salon compensation and pricing calculation as simple as data entry. The best part? The system is enabled with protections to make it impossible to “break” the formulas!
• The Salon Compensation and Pricing Guide, a 44-page instruction manual that not only explains how to use the system but also explains every formula so you’re never confused about what the numbers mean or where they came from.
• A 9-page Employer Obligations Information Sheet to keep you from making very common life-destroying mistakes.
• Be Worth What You Charge, an 11-page checklist and salon evaluation resource.