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Service charge reporting deadline postponed

Tuesday, December 18th, 2012

The Internal Revenue Service has given businesses an extra year to comply with new rules on how to treat service charges, until January 1, 2014. The new rules had been scheduled to take effect January 1, 2013, but the deadline was extended in response to public comments to allow companies time to make their accounting systems compliant.

If you operate a restaurant or other business where the receipt of tips is a part of the operation, this ruling is important to you. Last summer, Rev. Rul. 2012-18 defined the differences between tips and service charges, including illustrative questions and answers. Answer 1 contains the meat of the rules for determining whether a payment is a tip or a service charge. To be considered a tip to the employee:

  1. the payment must be made free from compulsion;
  2. the customer must have the unrestricted right to determine the amount;
  3. the payment should not be the subject of negotiation or dictated by employer policy; and
  4. generally, the customer has the right to determine who receives the payment.

Otherwise, the payment may be considered a service charge, even if it is called a tip or gratuity and distributed to employees. The amount is added to each employee’s wages, rather than tips.

Here’s an example: If your restaurant adds a gratuity of a specified amount, such as 18%, to a check for large parties, that gratuity is actually a service charge, not a tip. The amount is specified, compulsory, and dictated by policy.

Why is this important? A credit is available for employers who overpay their share of FICA taxes based on employees’ unreported tip income. A reclassification of payments as service charges rather than tips changes this calculation, because service charges are reported as wages and not tips.

Contact us for help to make sure your bookkeeping properly distinguishes between tips and service charges before the new year begins. This rule change will be much easier to manage if any needed adjustments are in place before your first payroll of 2013.

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Tags: deduction, income, payroll, small business, tax, tax credit, tax preparation, tax tips, tips, withholding

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