Automatic Gratuity: What You Need to Know

In the United States, it is customary to tip a server after a meal in a sit-down restaurant. Sometimes, restaurant owners can choose to add an automatic gratuity charge to a bill, but the purpose of this charge may be confusing for some customers. If your restaurant serves a lot of large parties or you're considering eliminating tipping, keep reading to learn more about what automatic gratuity is, the laws surrounding it, and some pros and cons to consider before you bring auto gratuity into your restaurant.

What Is Automatic Gratuity?

Auto gratuity is when a restaurant automatically adds a gratuity charge to the bill of a party. Usually, this gratuity is equal to 18% of the bill and is only applied to parties of six or eight or more. Generally, a restaurant will print this policy on its menu to alert patrons before they receive their bill.

In the past, the reason for automatic gratuities was often to ensure that a server was adequately compensated for handling a large party. A table of this size could want to split their bill, and as a result, confusion or miscalculation could arise and leave the server improperly tipped.

Auto Gratuity Law

automatic gratuity for large group in restaurant

In 2012, the IRS made a decision that would impact the classification of automatic gratuities starting in January 2014. Previously, money from automatic gratuity was counted as a tip. With this update from the IRS, automatic gratuity would now count as a service charge, not a tip.

What is the difference between a service charge and a tip?

A service charge differs from a tip in that a service charge is generally counted as a wage, whereas a tip is separate income. As a service charge, automatic gratuity is compulsory and is not an amount that customers choose to pay. Unlike a tip, automatic gratuity funds are considered restaurant funds and are not specifically designated as property of the server by the customer. An employer may choose to share part or none of the automatic gratuity funds with their employee.

This is particularly important to note in settings like banquet halls where each of a server’s tables will have automatic gratuity added to their bill. In this instance, the server is not receiving any tips, and so their income must be at least equal to the minimum wage of their state. If they were receiving tips, an employer could choose to pay an employee less than minimum wage because of their supplemental tip income. However, with automatic gratuity counting as a service charge and not tip, servers must be paid the legal minimum wage of their area for their shifts worked with only auto gratuity on guests’ bills.

Because of this designation as a service charge, income earned through automatic gratuity is taxed differently than tipped income. It must also be reported as wage on payroll reports, not as tips.

Is Automatic Gratuity Legal?

auto gratuity on a restaurant bill

The short answer is that yes, automatic gratuity is legal. Laws instated by the IRS rule that automatic gratuity is a service charge, and there is no legislation that prohibits this practice. This being said, state laws may differ on if this charge is compulsory. This is especially true if the automatic gratuity is not mentioned on the menu or customers are not informed by a restaurant employee of the charge before they receive it. To avoid potential confusion or conflicts, be sure to clearly state your automatic gratuity policy on your menu or have your servers inform any affected parties at the beginning of their meal.

Pros and Cons of Automatic Gratuity

Here are some pros and cons of implementing an automatic gratuity policy in your restaurant.

Pros of Automatic Gratuity

automatic gratuity on split restaurant bill
  • Helps avoid confusion when large parties split bills
  • Is a service charge designated as restaurant funds, so the restaurant owner can choose how to allocate the total

Cons of Automatic Gratuity

  • Requires restaurateurs to pay employees minimum wage for any shifts worked where no traditional tips were given
  • Discourages customers from tipping more than the gratuity, even if they would normally leave a 20% tip

While automatic gratuity can be helpful for ensuring adequate compensation after serving large parties, it can also bring about some challenges when it comes to your restaurant's bookkeeping. If you want to implement an auto gratuity policy in your establishment, be sure to familiarize yourself with the legislation regarding it in your state. Remember that automatic gratuity funds are taxed differently than tipped income for servers, and be sure to print your policy on your menu or somewhere else that is prominent to avoid confusion with customers.

Posted in: Management & Operation | By Christine Potts
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