Is a Service Charge at a Restaurant a Tip?

Restaurants often add a “service charge” to a bill, leading to confusion about whether this mandatory fee is the same as a traditional tip. While both involve additional payments, their nature, purpose, and tax implications differ significantly. This article clarifies the distinction between service charges and tips.

What is a Service Charge?

A service charge is a mandatory amount added to a customer’s bill by the restaurant. Customers are required to pay it as part of their total cost. These charges are considered revenue for the business, similar to income from food or drink sales.

Restaurants typically implement service charges to cover operational costs, such as increased employee wages, benefits, or to stabilize income for staff. The restaurant maintains control over how these funds are distributed among employees. From a legal and tax perspective, a service charge is not considered a tip.

What is a Tip?

A tip is a voluntary payment made by a customer directly to service staff in appreciation of service received. The customer has complete discretion over whether to leave a tip and the amount they choose to give. This payment is a direct gratuity to the server or other service employees.

Tips are generally considered the property of the employees who receive them, though they may be subject to valid tip pooling arrangements. The primary characteristic of a tip is its voluntary and discretionary nature, determined solely by the customer.

The Key Differences

The fundamental distinction between a service charge and a tip lies in their mandatory versus voluntary nature, which has significant legal and tax implications. The Internal Revenue Service (IRS) clarifies that if any payment is required by the employer, it is a service charge, regardless of what it is called. Conversely, a payment is a tip if it is made free from compulsion, the customer determines the amount, it is not subject to negotiation, and the customer decides who receives it.

For employers, service charges are treated as gross receipts and are subject to payroll taxes when distributed as wages. Employers must pay their portion of Federal Insurance Contributions Act (FICA) taxes, which includes Social Security (6.2%) and Medicare (1.45%), totaling 7.65% of the wages. Service charges are also subject to Federal Unemployment Tax Act (FUTA) taxes, which is 6.0% on the first $7,000 of an employee’s wages, though a credit for state unemployment taxes often reduces the effective rate to 0.6%.

In contrast, employers do not pay FICA or FUTA taxes on traditional tips, though they have reporting obligations. For employees, amounts distributed from a service charge are considered regular wages and are subject to income tax withholding and FICA taxes. Tips are also taxable income to the employee, and they must report all cash and non-cash tips to their employer if the monthly amount from one job is $20 or more. Employees are responsible for paying income tax and their share of FICA taxes on reported tips.

The restaurant controls the distribution of service charges, determining how the funds are allocated among staff or retained for business operations. Tips, however, are generally the property of the employees who earned them, subject only to valid tip pooling rules.