“How are service charges and autogratuities different from tips? How are they taxed and reported? Help!”
Tips include cash, credit payments, and other gifts, freely given to a worker by the customer, at the customer’s discretion. For a tip to truly be a tip, the following must be true:
- The tip must be given without compulsion and cannot be the subject of negotiations or salon policy,
- The customer determines the amount, and
- The customer determines who gets the money. (The only exception to this last factor is a proper tip pooling agreement.)
Tips are protected by federal law and must be distributed to the employee directly unless there’s a valid tip pooling agreement. Tips are generally considered the sole property of the employee.
Aside from the necessary payroll taxes and those permitted by state law, employers are not permitted to deduct any portion of the employee’s tip income.
In the beauty industry, most of us are considered “directly tipped employees,” meaning that our customers tip us directly. “Indirectly tipped employees” are workers who don’t typically receive tips from customers (like receptionists and assistants). Indirectly tipped employees generally cannot be part of a valid tip pooling agreement.
A tip pooling agreement requires all employees to contribute a portion of their tips, which are then divided among a group of employees. This group typically can only include employees who customarily receive tips, and can never include the salon owner or manager. The amount must be customary and reasonable and the employee must be making at least the prevailing minimum wage.
The FLSA prohibits any arrangement between the employer and the tipped employee whereby any part of the tip received becomes the property of the employer. The FLSA doesn’t impose a maximum contribution amount or percentage on valid mandatory tip pools, however, employees must be notified of any required tip pool contribution amount and the employer is still prohibited from retaining any of the employees’ tips for any other purpose, unless that purpose is expressly permitted by any applicable state laws.
Service charges and automatic gratuities are not tips, and an employer calling it a “tip” does not make it so. Service charges are not optional, determined by salon policy, distributed at the employer’s discretion, and are not protected by federal law, meaning that the business owner can claim any portion of the fee and isn’t required to turn it over in full to the employee. According to this Nolo article, “The law generally considers this part of the contract between the patron and the establishment, not a voluntary acknowledgment of good service by an employee.”
Employers choose how service charges are distributed or if they’re distributed at all. However, some states (New York, for example) require companies to surrender all mandatory service charges to their employees unless they clearly communicate to customers that the company is keeping the money. In Washington, companies are required to inform customers on menus and receipts what portion of their service charges goes to the workers.
Deducting Credit Card Fees from Tips
Federal law permits employers to deduct the cost of credit card fees from tip amounts, but this charge on the tip may not reduce the employee’s wage below the required minimum wage. The fee charged must only account for the fee on the tip amount, not the amount of the entire bill. However, some states prohibit deductions of any kind from tips, including credit card fees (California is one of them), so check your state law.
Both directly and indirectly tipped employees are required to report monetary tips (cash/credit) to their employer, unless they’ve earned less than $20 that month in tip income. Non-monetary tips (like show tickets or other goods) typically don’t have to be reported. All monetary tips are included in the employees’ gross income and are subject to federal income taxes, so employers are required to withhold and remit the appropriate employment taxes.
Service charges that employers distribute to employees should also be treated as regular wages for tax withholding and filing requirements.
This post is nothing more than a reference, so there are no opinions in here, and regarding the practice of tipping, I have quite a few strong ones.
Have any questions about tips? Hit the comments and I’ll be happy to point you at some references!