The IRS has announced it is giving taxpayers until Jan. 1, 2014 to change their automated and manual reporting systems in order to comply with the proper treatment of service charges vs. tips.
In Rev. Rul. 2012-18 issued earlier in the year, the IRS spelled out the circumstances when an amount paid is to be reported as a service charge, as opposed to a tip. Generally, a tip is a payment made free from compulsion where the customer has the unrestricted right to determine the amount paid and who should receive the payment. Service charges, on the other hand, are amounts added automatically to the customer’s bill, usually as a set percentage. This is a common practice in banquet-type events and for large groups at restaurants. Service charges are to be reported as wages and are not eligible for the FICA tax credit on tips. As a result, the amounts paid as service charges need to be handled separately from tips.
In Rev. Rul. 2012-18, the IRS instructed examiners to apply these rules to amounts paid after Jan. 1, 2013. The IRS received many comments from businesses on the numerous changes that would need to be put in place to comply by that date. The IRS subsequently issued Announcement 2012-50, which instructed examiners to apply the rules for amounts paid after Jan. 1, 2014. This is a welcome relief for the restaurant industry as it copes with how to change procedures and systems to capture service charges where appropriate.