Do You Know the Difference Between a Tip and a Service Charge?

As we move deeper into the holiday season, you’re probably seeing an uptick in big parties. Are you adding autogratuity to the bill? That’s not a tip — it’s a service charge. And that means you need to treat it differently.

Any non-discretionary charge added to a customer’s bill, regardless of what it’s called, is a service charge. Autogratuities fall into this category, as do things like health and wellness charges, back-of-house service charges, and anything else that a customer can’t opt into. Service charges are considered revenue to your business, and you are required to collect sales tax on them. Because service charges are considered revenue, they can be allocated to employees as you see fit, and they do not count towards the tip credit (not even autogratuities, even if you allocate them back to the server who collected them).

Tips, on the other hand, are non-compulsory gifts given from patrons directly to employees. They are not considered business revenue and sales tax is not collected on them. Depending on your business model, tips may be pooled, and you may apply a tip credit for all regularly tipped employees. As tips are the property of the employee, a business is severely limited in how tips can be allocated.

Tips vs. Service Charges (Auto Gratuities)

	*Tips*	*Service Charges (Auto Gratuities)*
Payment	The payment must be made free from compulsion and the customer must have the unrestricted right to determine the amount.	Service Charges are amounts of money employers require customers to pay. The customer does not have the right to determine the amount of the service charge.
Payment Type	Tips are considered a gift from patrons directly to the employee.	Service charges are considered revenue to the business.
Sales Tax	Sales Tax is not collected on tips to employees.	Sales tax must be collected on all service charges because they are considered revenue.
Tip Pooling	Tips can be pooled among other employees as long as patrons are made aware that there is a tip pool at the restaurant.	Service charges can be allocated within the business however ownership sees fit. Any portion of a service charge given to an employee does not count toward the tip credit.
Payroll	Tips reported to the employer must be included on Form W-2 in Box 1 (Wages, tips, other compensation, Box 5 (Medicare wages and tips), and Box 7 (Social Security tips).	Service charges being allocated to employees should be treated the same as regular wages for tax withholding and filing purposes.
Owners / Managers	Owners, managers, and supervisors can never take part in a tip pool.	Service charges can be used to compensate owners, managers, and supervisors.