Happy New Year!
I recently received a question about the new rules for tipped employees. Our client graciously permitted me to post the answer to HRConnect:
IRS Rev. Rul. 2012-18 addresses an employer's tax
withholding and reporting of "mandatory tips." Unlike tips that are
subject the reporting obligations only to the extent disclosed by the employee,
IRS Rev. Rul. 2012-18 states that automatic gratuities are not
"tips," but rather service charge “wages.” It is the employer’s
responsibility to monitor and track all service charge wages, including the
obligation to withhold on these wages and report them to the IRS. The
employee's monthly tip reporting obligations simply don't apply to these
mandatory tips/service charges.
IRS Rev. Rul. 2012-18 states
whether a payment is a tip or a service charge wage is a factual determination,
but absent one of the following criteria, the payment likely is characterized
as a wage, rather than a tip if: (i) the guest’s payment must be made free
from compulsion; (ii) the guest must have the unrestricted right to determine
the amount; (iii) the payment should not be the subject of negotiation or
dictated by the hotelier’s policy; and (iv) generally, the guest has the right
to determine who receives the payment.
The IRS provides an interesting yet
rare example of how this works: if an employer merely includes sample tip
amounts on the bill, and the tip line is left blank, the amount the customer
adds to the bill is considered a "tip" and not a “wage” for federal
tax purposes.
Once the "tip" is
designated as a "mandatory tip", it becomes part of the employee's
wages paid by the employer. This will affect the employee's rate of pay since,
as wages, mandatory tips must be included into the regular rate of pay for
non-exempt employees, unless a basis for exclusion can be found in the FLSA.
If these mandatory tip amounts are
not incorporated into the employee's hourly rate, the employee's overtime wages
will be calculated incorrectly, resulting in an underpayment of wages to the
employee. This could lead to a DOL investigation, lawsuit or class
action lawsuit. In fact, class action lawsuits are increasingly being
filed against employers, accusing them of the improper failure to include service
charges and "mandatory gratuities" into the calculation of employees'
regular rate of pay.
Employers have implemented three
strategies to prevent class action lawsuits being filed against them on this
basis. The first is to simply do away from service charges and mandatory
tips. The employers who employ this strategy typically raise prices to
compensate for the loss in revenue.
The second strategy is to spend the
necessary time and effort to understand the new rules and to ensure they are
being followed.
The last strategy is to implement
an employee arbitration program that prohibits class action lawsuits being filed by
employees against employers. Such arbitration programs have been upheld as valid by
various courts recently, including the U.S. Supreme Court, albeit in a
different context. Other advantages of the arbitration program are that
since there is no jury, there is no “runaway” jury when it comes to penalizing
the employer. Further, since arbitrations are confidential, they do not
show up on the internet or in newspapers, thus preventing corporate
embarrassment and copycat lawsuits from other employees. Finally, since
arbitration programs apply to a very broad scope of employee disputes, they can
also prevent class action lawsuits arising from claims of discrimination,
harassment, hostile work environment, retaliation, etc.