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Should Tipping Be Banned? -- Legal Considerations of Banning Gratuities

By Ephrat Livni, Esq. on October 20, 2015 | Last updated on March 21, 2019

Service businesses are increasingly discussing the elimination of a tipping system. Many servers think it is unfair. Many customers would prefer if businesses handled employee pay independently and left them out of it altogether.

If you want to ban tipping in your business, will it cost you more than you can afford?

Tipping Defined by the Department of Labor

There are a few legal considerations that arise here, not least of which is navigating the thicket of laws regulating service businesses and ensuring you are in compliance with federal, state, and local requirements. Also a notable notion, no more tips means employees must receive the minimum wage and you will be the one to pay.

If you ban tipping, are you willing to make up the difference in employee pay? According to the US Department of Labor, tipped employees are those who receive more than $30 per month in gratuities.

Employers may use the money received in tips as a credit toward minimum wage beyond the $2.13 hourly rate they must pay, but not at a rate of more than $5.12 per hour (the minimum wage of $7.25 minus the minimum required cash wage of $2.13).

You will need to make up this difference for every employee who is currently characterized as "tipped" in your taxes. That is a serious chunk of change.

The IRS on Automatic Gratuities

So what about an alternative tipping structure? You might make tipping mandatory, building a service charge into your business. For example, many restaurants charge a mandatory 18% service charge on tables of six or more people.

But mandatory service charges are subject to IRS scrutiny and different rules than regular tipping. In the words of the tax collecting agency, "Unlike tips that subject the employer to tax withholding and reporting obligations only to the extent disclosed by the employee... automatic gratuities are not "tips" under the law, but rather service charge wages."

The IRS explains. "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."

And that is just the tip of the iceberg. There are numerous legal and financial considerations. You must make sure you are square with the feds, the state, and the place where you do business.

A Tip From Counsel

Before you make any drastic moves, speak to an attorney. A lawyer can help you think through the implications of any decision. Critically, if you do decide to act, counsel can ensure that what you do is kosher.

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