The Morning Report
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Determination: Mostly True
Analysis: For some time now, the forced gratuity added to the bill by some businesses — often when a group of six or more people dines at a restaurant — has stirred debate among diners and employers. But there was an avid fan of this mandatory charge here in San Diego.
Jay Porter, former owner of The Linkery, was forthright about the idea that “tipping encouraged selfishness rather than teamwork.” It led him to get rid of tips at his restaurant and implemented a mandatory service charge instead.
Porter was talking up the benefits of such a structure as recently as last summer:
By replacing tipping with a service charge, we were legally able to redirect about a quarter of that revenue to the kitchen, which reduced the income disparity and helped foster unity on our team.
Porter’s way of doing business got national attention, but his approach could be facing extinction, thanks to an Internal Revenue Service decision on automatic gratuities that took effect Jan. 1.
Matt Gordon, owner of Urban Solace, Solace & Moonlight Lounge and Sea & Smoke, brought up the new rule in a Voice of San Diego op-ed. He said the automatic gratuity approach would be a “bureaucratic nightmare” for Porter or other restaurateurs because of the new IRS ruling:
I have nothing but respect for what he tried to do at The Linkery. But I think his audience was narrower than he hoped, and that made it incredibly difficult to make money. The IRS’s recent decision to get rid of automatic gratuities throughout the U.S. would have made it even harder for him. His payroll would have been a bureaucratic nightmare under the new system.
Gordon is basically claiming that mandatory gratuities would vanish nationwide, which is mostly true. The fact is the IRS decision, enforces automatic service charges to be considered as wages, not tips.
The ruling could put an end to the practice of mandatory gratuities nationwide, or it could simply curtail it. The fact is the option is still there for employers, but it comes at a price.
San Diego State accounting professors Nathan Oestrich and Steve Gill said the ruling would snip employers’ benefit of using these service charges as credit in their FICA tip credit calculation.
The charges are now considered part of employees’ hourly wages, which create a financial burden on employers’ when calculating overtime wages.
“I cannot think of any direct effect this would have on employees,” Oestrich said. “But this revenue ruling makes it clear that the employer calling an item a ‘tip’ is not deterministic as a tip by the IRS.”
Aside from restaurants, the decision also impacts nightclubs, hotel and resort service charges and take-out food delivery charges.
Diners give about $42 billion in tips every year, according to economist Ofer Azar.
With the new ruling, the IRS will only consider an amount a tip if it satisfies these four factors:
1. The payment made must be the customers’ decision.
2. The customer has the right to decide on the amount.
3. The payment should not be negotiated or influenced by the employer policy.
4. The customer has the right to determine who gets the payment.
Gordon said the new IRS ruling would get rid of automatic service charges nationwide. It’s likely most restaurants will get rid of such charges because they’ll create financial hardships for employers, but the IRS is not eliminating them. The IRS is simply enforcing the charges as wages, and not tips.
Gordon clarified to me this week that the rule will likely force employers’ hands, in effect eliminating most automatic gratuities – but that the rule doesn’t eliminate them outright on its own.
“They are being done away with by a vast majority of restaurants because how we have to track labor becomes nearly impossible under the new rule when automatic gratuities are now considered wages and not tips,” said Gordon. “I am, and was well aware that automatic gratuities are not illegal, just that no one in their right mind will tack them on to bills anymore.”
That makes his original statement mostly true. It is accurate, but there is an important nuance to consider.