HR Glossary | 4 minute read

Service Charge vs Tip

A service charge is a mandatory fee a business adds to a customer's bill. A tip is a payment the customer chooses to make and sizes alone. The difference decides whether the money is employer income, employee wages, or a tip.

Many employers trust the label on the receipt. The IRS says that calling a payment a tip does not make it one. Customer choice decides, and that choice drives overtime and payroll tax.

How Do the DOL and IRS Define Each One?

The DOL says a compulsory charge for service, such as 15 percent of the bill, is not a tip under the Fair Labor Standards Act. Sums paid out from it are not tips either.

The IRS says a payment is a tip only if the customer voluntarily decides to pay it and determines the amount. Rev. Rul. 2012-18 adds that it should not be negotiated or dictated by employer policy.

Why Does the Label on the Bill Matter?

Because the label does not control the outcome. In Rev. Rul. 2012-18, a fixed 18% charge dictated by the employer is not a tip, whatever the receipt calls it.

A blank tip line works the other way. When a bill shows suggested percentages but the customer can enter any amount or leave the line blank, the payment is voluntary and is a tip.

Checkout screens count too. The IRS lists digital payment prompts that require a customer to select a tip greater than zero as service charges. A forced choice is not a tip.

How Are Service Charges and Tips Paid and Taxed?

Service charges are gross income to the employer whether or not they are distributed. Any amount paid to employees is wages, goes on the employee's Form W-2, and counts as FICA wages under Rev. Rul. 2012-18.

Tips reach payroll through employee reports. The employer withholds income tax and the employee's Social Security and Medicare tax on wages and reported tips, and includes reported tips in W-2 Box 1.

Question	Service charge	Tip
Who sets the amount	The business	The customer
Whose money first	The employer's	The employee's
Payroll treatment	Wages on Form W-2	Reported tips, in W-2 Box 1
Minimum wage	Distributed sums may satisfy the obligation	Counts only through the tip credit

Distributed service charges may satisfy minimum wage and overtime obligations and must be included in the regular rate of pay for non-exempt employees.

Can an Employer Keep a Service Charge?

DOL's overtime advisor says service charges are part of the employer's gross receipts. The employer has complete discretion over their use, including whether to pay employees from them.

Tips are different. The FLSA prohibits employers from keeping any portion of employees' tips. Because the rules diverge, menu and check wording should match how the money is actually handled.

How Does HR Cloud Help With Service Charge Records?

Classifying the charge is a policy and payroll decision. The hours behind the pay still need clean records. HR Cloud's Time Clock lets employees enter time in HR Cloud or on a mobile device, and managers approve timesheets in one click.

The food and beverage page lists Shift Planner, Time Clock and People HRIS among its core HR features. To see them with your teams, request a demo.

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Frequently Asked Questions

Q: Do service charges count toward the tip credit?

A: Not as tips. DOL says tips an employee receives in addition to the charge may still be considered in deciding tipped-employee status and applying the tip credit.

Q: What records must employers keep for distributed service charges?

A: The IRS says to keep the employee's name, address and Social Security number, the amount and date of each payment, and the taxes withheld. Store them with other employee records.

Q: Do service charges qualify for the federal deduction on tips?

A: Generally no. The IRS says qualified tips do not include service charges unless the customer has an option to disregard or modify the charge.

Q: Is a service charge payment a commission?

A: DOL's overtime advisor says that when an employee is paid from the compulsory charge, the payment is considered a commission payment and not a tip. Treat it as pay.

Q: Do employees report service charges to their employer as tips?

A: No. Employees report cash tips unless the total is less than $20 per month from that employer. Distributed service charges are wages the employer already records.

Q: Can state law change these rules?

A: Yes. DOL says that when state law differs from the FLSA, the employer must follow the standard most protective to employees. Check your state labor agency.