Need to Know - Tips and Service Charges

Under New York Law (NYLL § 196-d), employers are not allowed to keep any portion of employees’ tips, except for credit card charges, which are typically an extremely small percentage. This sounds simple enough, but where it gets complicated is when employers dispute what counts as a “tip.” An amount that a customer adds on the “tip” line of a credit card receipt or left as cash on a table is clear enough—although we at Pelton & Associates still all too often employers who simply grab part or all of employees’ tips. But what happens when a restaurant or catering business automatically adds a “service charge” to a customer’s bill? Where should that money go?

As with many issues in employment law, the short answer is, “It depends.” If a reasonable customer would think that the service charge functioned as a tip, then it must be treated as such by the employer and distributed to service employees.

A service charge may be considered something other than a tip if an employer takes certain steps to alert customers that the amount does not function as a tip, such as stating in a readable font on a bill or menu that the service charge is not a gratuity, stating the purpose of a service charge and the formula used to calculate the amount (for example, “A 10% service charge will be added to all events with over 100 people to cover the costs of coordinating and overhead”), having a separate line on a bill for gratuities or tips in addition to a service charge and notifying customers in discussions of catered events and invoices that service charges are not gratuities

The IRS also has updated rules about when a payment is considered a tip and when it may be considered a service charge for reporting purposes. A tip should be: made voluntarily by the customer, made in any amount the customer desires, not a subject of negotiation or set by the employer’s policy, and distributed to employees as the customer sees fit (although this does not invalidate otherwise permissible tip pooling/tip sharing arrangements).

The general rule in New York and certain other states is that when in doubt, a service charge is considered a gratuity and should be paid to service employees. For more information on laws regarding tips and payment of tipped employees, visit our discussion of unpaid gratuities.