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State Board of Equalization Clarifies Position on Taxability of Mandatory Tips


If your restaurant is automatically adding gratuity to your customers' checks, be sure that you're adding sales tax as well to avoid the predicament faced by Darden. Its GMRI subsidiary didn't charge sales tax to customers on its addition of an "optional" gratuity of 15 percent to 18 percent for parties of eight or more and had significant fines and penalties levied against them as a result. On November 15, 2011, the California State Board of Equalization ("SBE") clarified its position regarding the sales taxability of mandatory tips.

In general, SBE ruled that when "a mandatory payment designated as a tip, gratuity or service charge is included in taxable gross receipts" then "…a payment of a tip, gratuity or service charge is only optional if the customer adds or reduces the amount to the bill."

GMRI contended that the tips were not mandatory because the menu statements included the word "optional" and allowed the customer to alter the tip amount or refuse to pay it completely.

Even though the customer had the ability to alter the automatic tip amount, the SBE concluded that the automatic inclusion of the tips on the bill was considered mandatory, and stated that in situations where the customer altered the automatic tip amount, by writing in a different amount, such tips were optional and not subject to sales tax.

If the customer did not alter the automatic tip and then paid an additional tip amount, only the automatic tip amount was subject to sales tax. The regulations provide examples of situations in which tips are not considered taxable. One example, which a restaurant should consider in lieu of a mandatory tip automatically included in the bill, is a "suggested tip." A restaurant can avoid having to treat tips as taxable by including at the bottom of the bill a "suggested tip" at various rates and leaving the actual tip section blank for the customer to complete.

For more detailed information see SBE Publication 22, Tax Tips for the Dining and Beverage Industry & Cal. Code Regs. 1603 (g)(1). Restaurant owners can review the SBE publication and the regulations to determine if they comply with the rules regarding sales taxability of tips. For further information on this or other industry topics, please contact Gary Levy, CPA, partner and director of J.H. Cohn's Hospitality Industry Practice, at glevy@jhcohn.com or 646-254-7403; Marshall Varano, CPA, partner and a member of J.H. Cohn's Hospitality Industry Practice, at mvarano@jhcohn.com or 858-300-3424; Jeffrey A. Bobrosky, CPA, a partner and member of J.H. Cohn's Hospitality Industry Practice, at jbobrosky@jhcohn.com or 818-205-2640; or your J.H. Cohn engagement partner at 310-477-3722.

Download the full PDF.

Published date: 12/22/2011

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