2014 IRS Rules for Mandatory Gratuity: Dallas employment lawyers

Beginning January 1, 2014, the IRS began enforcing rules on restaurant mandatory gratuities that will have an impact on both the income of tipped employees and how restaurants can get themselves in hot water with the Department of Labor and/or IRS by misapplying these mandatory gratuities. Restaurants typically charge these mandatory service charges for large parties, which may be as few as six people. The added charge usually ranges from 15-20%.

Under Texas and federal employment law, these mandatory gratuities belong to the restaurant; the restaurant is not required to give any portion of that mandatory charge to the employees. (Some other states treat them differently.) Some restaurants give employees some of the mandatory gratuity to make sure the tipped employees receive sufficient tips. The rules enforced by the IRS are not new; they are based on existing Department of Labor regulations for tipped employees. The IRS has just clarified how it will enforce the rules from a tax perspective going forward. The rules are “new” to the IRS but not to the DOL.

The Department of Labor’s regulation on mandatory gratuities

The Fair Labor Standards Act and accompanying DOL regulations require waitstaff to receive minimum wage based on the federal minimum wage. However, tipped employees who meet the requirements under the FLSA can have their minimum wage reduced by a tip credit so that at least some of the tips earned will count as part of the minimum wage requirement. That turns the employee’s minimum wage into $2.13 per hour instead of $7.25. (Although if the employee does not earn enough tips for the full credit the employer must make up the difference.)

The DOL’s position on mandatory gratuities is that any portion passed on to the tipped employees is wages. It cannot be part of the tips to determine the amount of the tip credit. Because it is wages, it affects overtime pay. The employer must treat the employee’s share of the mandatory gratuity as an amount above minimum wage so any hours worked above forty in that work week must be paid at an overtime rate of one and a half times the minimum wage plus whatever amount was paid out from mandatory gratuities.

This is not a new rule. Many employers have no doubt been violating this rule for some time. Employers are waking up to this regulation due to the change in the IRS regulations. If you have been underpaid on overtime pay due to misapplying the tip credit on mandatory gratuities you may be eligible to receive unpaid overtime pay.

The Internal Revenue Service’s regulation on mandatory gratuities

Pre-2014, the IRS treated amounts of mandatory gratuities paid to tipped employees as tips so the employer did not have to pay payroll taxes on these amounts. As far as the IRS, no distinction exists between tips received through the mandatory gratuity and regular tips. Beginning January 1, the IRS has changed its rules to align with the DOL’s regulation. The IRS now treats the employee’s share of the mandatory gratuity as a wage and now subject to payroll taxes. That makes it more expensive for the restaurant to charge a mandatory gratuity than it is to leave an open tip line and let the tipped employee get whatever the table leaves as a tip.

The IRS distinguishes between a tip and a service charge based on four factors: (1) the customer is free to not pay the requested amount; (2) the customer is unrestricted in determining how much to pay; (3) the employer does not determine the amount based on its policy and does not negotiate the amount with the customer; (4) the customer has the right to determine who gets the money. Basically, the employer can suggest an amount of gratuity for large parties (or any table) but it cannot require you to pay a set amount without turning it into a service charge subject to the new rule.

As a result of this new IRS rule, many restaurants are abandoning the mandatory service charge. Others keeping the service charge are now looking at the overtime issue that they had previously ignored.

If you are a tipped employee not paid overtime correctly

If underpaid overtime on an incorrect calculation of the tip credit then you may receive unpaid overtime plus interest. Under the Fair Labor Standards Act, you can also receive attorney fees and court costs. That allows attorneys to represent tipped employees who may not have the money for the employment lawyer‘s hourly rate. If you believe you have unpaid overtime it is important that you act quickly to speak with an employment lawyer. Pay-related claims are subject to a statute of limitations. Waiting may result in losing the ability to recover on some of your past paychecks. Visit the overtime and unpaid wages page to learn more about your rights.

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