Anyone who enjoys a meal at a restaurant or stays in a hotel is likely to confront the question of what gratuity to give service professionals, such as waiters, bartenders, bussers, dishwashers, porters and maids. Some American hotels and restaurants have transitioned from the traditional tip system to a service charge system, which is more common in Europe. However, this only increases the need to understand the difference between employee tips and service charges.
Understanding Gratuities and Service Charges
A gratuity is a voluntary and discretionary payment that customers may make to service professionals, and it's an amount added to employee wages received. While gratuities usually show appreciation for exceptional service, some customers give intentionally small gratuities or no tip at all to show their displeasure.
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The Consumer Financial Protection Bureau suggests common tip amounts ranging from 15 to 20 percent. This money may go entirely to the service professional directly, or it could go to a tip pool if there's a tip-sharing arrangement. Depending on the situation, you might leave cash tips or have the amount added to your bill if you're using a credit card.
A service charge is similar to a gratuity only in that it's also an additional payment in a situation involving a service professional. Examples of service charges include a hotel room service charge, banquet event fee or cruise trip package fee. In addition, an automatic gratuity for a dinner would be classified as a service charge. It's important to note that a mandatory service charge may or may not deliver additional pay to the service professional.
Labor Laws on Gratuities and Service Charges
Some state laws address the difference between service charges and gratuities. This occurs when a state allows certain employers to take a credit for workers who earn the minimum wage or pay workers less than the state or federal minimum wage. The result is that service workers who earn tips may not be eligible for minimum wage protection and thus receive a lower tipped employee wage.
Per federal law, if employers collect service charges, they may not claim tip credits or pay their workers less than the minimum wage, mentions the U.S. Department of Labor. This remains the case even if they deliver the service charge earnings to workers as supplemental pay.
Labor laws also require employers to deliver electronic payment method gratuities to service professionals within one pay period.
Tax codes also deal with gratuities and service charges. According to the IRS, workers who earn tip income must report it to their employer, who is responsible for withholding income and FICA taxes from gratuities as well as regular wages. Tipped employees must then report their income from electronic and cash tips as part of their taxable earnings on year-end tax returns for state and federal income taxes.
Workers only pay taxes on service charges if and when they receive them as payment. This occurs when an employer distributes these nontip wages to service workers at the end of a day, week or pay period. The Washington State Department of Labor & Industries explains that service charge income given to employees is also subject to tax withholding.
All employee earnings and withheld taxes will be included in the relevant boxes on the Form W-2 that employees receive at tax time.
Considerations for Tips and Service Charges
The differences between service charges and gratuities matter to customers as well as business owners and service workers. Except for restaurants, where customers can add gratuities to their bill, many gratuities are paid in cash, which requires customers to travel with small bills to provide tips as needed. Service charges eliminate the need to carry cash as well as the need to compute an appropriate gratuity on the spot.
On the other hand, service charges remove the opportunity for a customer to recognize poor or excellent service by changing the amount. Therefore, OpenTable suggests leaving a tip for good service in addition to paying the service charge, especially if the charge isn't at least 20 percent of your bill.
- Consumer Financial Protection Bureau: Figuring Out How Much to Tip
- IRS: Topic No. 761 Tips – Withholding and Reporting
- U.S. Department of Labor: WHD Opinion Letter FLSA2021-5
- Washington State Department of Labor & Industries: Tips and Service Charges
- OpenTable: What You Need to Know About Tipping at Restaurants Today: How Much, When, and Why