INDIANAPOLIS -- When Thomas Howard sees an automatic gratuity on a restaurant bill, one thing is for certain: His server won't be getting any more than that amount.
If restaurants tack on the charge to his bill, the Indianapolis resident said he doesn't think servers should expect any more. But when it comes to leaving less than the tacked-on charge, he didn't know that was even an option.
"I don't think you can, can you?" Howard asked. "You've got to go by whatever their policy is."
He's confused - and a little put off - by the whole "automatic gratuity" practice. He's not alone.
Even with automatic tipping, customers have always faced a decision over how much to leave a server. Now, thanks to an IRS ruling, restaurants are being thrown into the debate - and are faced with a decision of their own: Should tipping for large parties be left to the customer or should the restaurant tack it on to the bill?
The IRS ruling, which takes effect in January, will treat automatic gratuities as service charges, rather than tips. The switch means servers will no longer be responsible for reporting those automatic tips as income. And it also means automatic gratuities will be considered a part of a server's wages, making that money subject to payroll tax withholding and delaying receipt until the next paycheck.
Understandably, many servers aren't happy about the tax policy, but neither are restaurant owners. The change will create additional accounting and bookkeeping work, because automatic gratuities will have to be factored into hourly pay rates that could vary depending on the number of large parties served by the employee.
The IRS policy change also could mean the loss of an income tax credit, which restaurants receive for paying Medicare and Social Security taxes on employees' reported tips. Service charges are not eligible for the credit.
"It's a big deal because it impacts, in one way or another, 10 percent of the workforce in the state of Indiana," said Patrick Tamm, president and CEO of the Indiana Restaurant and Lodging Association. "Not all employees in restaurants are tipped employees, but they could still pay for it."
Restaurant hiring also could take a hit as a result of the IRS ruling, Tamm said.
"It could affect hiring if restaurants continue to be faced with additional costs and burdens to comply with government mandates and regulations," he said.
Some dropping practice
Several restaurants are wondering whether the right course of action might be to eliminate automatic gratuities.
The Melting Pot on Indianapolis' Northeastside no longer puts an 18 percent automatic gratuity for parties of six or more on checks, owner Bennet Ackerman said.
"It's going to hurt us as employers, because now I'd be paying taxes on that as a wage, which in the past I haven't," Ackerman said. "Between that and the health care reform, it's adding one more burden to employers."
After The Melting Pot stopped automatic gratuities, server Michael Turney noticed a decrease in the amount of tips he received.
"I feel like larger parties don't tip as well as they should for the amount that they spend at the restaurant," said Turney, who has been a server at The Melting Pot for 2 1/2 years. "When they spend $200 and leave $20, you're losing out on about $16 or $17, when we already pay a tip out to a host, bartender and bussers. It really makes the income of a server go down."
The change also has made many servers reluctant to take on the extra work of serving large parties, Turney said, when they can make more tips off smaller parties.
Darden Restaurants - which operates Red Lobster, Olive Garden, Longhorn Steakhouse Seasons 52, The Capital Grille and other chains - is testing a concept that eliminates 18 percent automatic gratuities for parties of eight or more, and instead leaves tip percentage calculations at the end of a bill.
The restaurant group is experimenting with the tip suggestions in 100 restaurants in four markets across the country and will decide whether to keep the automatic gratuity or do away with it at all locations by the end of the year.
"What we have seen so far is that guests appreciate the convenience factor," said Darden spokesman Rich Jeffers, "and our employees appreciate the fact that we're seeking to preserve those tips for them."
Worries about coercion
Marianna Dyson, a Washington, D.C.-based lawyer who represents restaurant chains, said, "The IRS has signaled its intent to scrutinize auto-gratuity patterns to determine whether they are tips, or if there has been more coercion so it becomes more of a service charge."
Industry experts said the ruling also may be a way for the IRS to combat the fact that many servers do not fully report their tips.
"I don't think we can always assume it's a perfect system and every dollar that is being tipped is being reported," said Judith Hack, an associate professor of hospitality and tourism management at Purdue University-Calumet. "Maybe this is the first in a series of tightening up."
Servers, who make $2.13 an hour in Indiana, are likely to be the most affected by the change, experts said. Rather than receiving automatic gratuities at the end of the night, under the new IRS rule, those payments would be tacked onto paychecks as wages. That could adversely impact servers who have come to depend on that extra cash.
But, on the flip side, some servers prefer receiving tips on their paychecks because it makes budgeting - and saving - easier. It's also easier to calculate income at tax time.
As restaurant industry workers try to make sense of the effects of the ruling, Dyson, the attorney for restaurant chains, said the IRS needs to create clearer guidelines.
"How far can a restaurant go to suggest an appropriate tip amount, before it is converted to a service charge?" she said. "What does a check need to say? How do you have the discussion with the guests? That's where I think the next frontier is with the IRS, having those discussions."