What is the difference between a tip and automatic gratuities?

Restaurant based credit card accounts and point of sale systems have the ability to include a tip line and a Automatic Gratuity on the receipt. And now the various taxing agencies including are getting involved.
We’ve all had this experience at one point or another when going out to a restaurant with a group of six or more. The 18% automatic gratuity that is added to the bill giving us little choice to pay-for-performance. This is called auto gratuity. Interestinngly, the IRS has a well defined difference between a tip and an auto gratuity. IRS Bulletin 2012-26, Revenue Ruling 2012-18 defines a tip as:
– The payment must be made free from compulsion;
– The customer must have the unrestricted right to determine the amount;
– The payment should not be the subject of negotiation or dictated by employer policy;
– And (generally), the customer has the right to determine who receives the payment.
So a restaurant that imposes a fixed rate via auto gratuity is charging a service charge and this is not considered a tip. And starting on January 1, 2013, this will has several tax implications for the business as local and federal taxing agencies will require all businesses to report a service charge not as tips.According to the IRS, “service charges, including auto gratuities must be properly characterized as wages and not tips. Service charges are not to be included in any calculation that arrives at an hourly tip rate, a tip rate calculated on a percentage of sales, or any other rate determination method.”
So are businesses going to be forced to eliminate Automatic Gratuity? Well, that depends on how each business wants to handle the matter.
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