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I am asking this question in relation to recent talk about exempting tipped wages from income tax. This is something that seems to be supported by both Kamala Harris and Donald Trump in their presidential campaigns this year.

No tax on tips: Why politicians love it, and economists don't

When it comes to tips is there anything specific that makes it a tip or would disqualify it from being called a tip? This is being asked due to the practice that some businesses have of adding a "mandatory" tip to the bill for various reasons such as the number of people in the party.

For the purpose of tax law today are/can these mandatory charges classified as tips or as something else?

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    The final paragraph narrows this question enough to be on-topic for Law.SE. However, such future laws need not match existing tax law. You may wish to consider asking some form of this question on politics.SE (i.e., what the politicians are proposing). Mind you, I'm not sure politicians have fleshed out this proposal enough for it to be currently answerable.
    – Brian
    Commented Aug 19 at 14:11
  • @Brian this question would be off topic on politics se and I would vote to close it. The question doesn’t depend on what could change with new laws rather how things stand right now. The part about possible future laws is just background for why I asked.
    – Joe W
    Commented Aug 19 at 15:20
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    Worth noting that it wouldn't be surprising if the definition of tips for the purposes of the Fair Labor Standards Act (federal minimum wage and overtime law) could also be utilized. That definition is discussed at dol.gov/agencies/whd/flsa/tips
    – ohwilleke
    Commented Aug 19 at 17:54
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    Another definition that could be used was the definition of tip used prior to 1987. Prior to 1987 just the amount necessary to bring a tipped wage to a minimum wage was subjected to FICA taxation, but after 1987 all tips were. See ssa.gov/policy/docs/ssb/v51n4/v51n4p4.pdf There is also a definition uses for the FICA tip credit for employers under current tax law. See irs.gov/pub/irs-access/f8846_accessible.pdf
    – ohwilleke
    Commented Aug 19 at 18:08

3 Answers 3

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From the IRS website:

Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers.

Further down, the following criteria are given:

Q&A 1 of Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:

  • 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.

Pooled tips count as tips, but "auto-gratuities" that many restaurants add for large parties do not.

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    "Pooled tips" seems to contradict the last bullet point since the customer can no longer direct who receives the tip if it is pooled.
    – Roddy of the Frozen Peas
    Commented Aug 19 at 15:27
  • I noticed that as well. But notice that it says "creates a doubt" -- they're not absolutes. Also, "generally".
    – Barmar
    Commented Aug 19 at 15:29
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    Customers don't usually know whether the restaurant pools tips. So the customer thinks the tip goes to their waiter.
    – Barmar
    Commented Aug 19 at 15:30
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    Anyway, if IRS contradicts themselves it's not my problem, it's for a judge to resolve.
    – Barmar
    Commented Aug 19 at 15:34
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    Tip pooling is allowed because the law explicitly says it is allowed. As you might expect, the relevant CFR section goes into far greater detail, but that is technically regulation and not law, so with the death of Chevron, it is possible the courts will see fit to alter it.
    – Kevin
    Commented Aug 19 at 17:51
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The mandatory service charge would be considered a "controlled tip" and is considered salary for Canadian tax purposes.

Both controlled and direct tips receive the same ultimate tax treatment.

The main difference between a mandatory service charge (a controlled tip) and an optional add-on by the customer is that the mandatory service charge carries withholding and reporting obligations for the employer (e.g. for pension and employment insurance).

Regardless, all tips, gratuities, and salary received due to controlled tips must be included in a person's reported income each tax year.

As for hypothetical future laws, they could easily be written to exempt all tips including "controlled/mandatory tips" from taxation, or only direct tips, or no tips. One possible dividing line, if desired, is whether the employer/establishment mandates the fee and controls its distribution.

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I imagine a pretty universal criteria for a "tip" is that it is not a charge quantified by the establishment, or for which payment is called by the establishment.

So a "tip" called for on the bill is not a tip, but a service charge.

Not being quantified by anyone other than the payer, by definition it is also not mandatory. It is a gratuity, which would not be received in every transaction or at any minimum level.

I don't see how any mandatory charge enforced by the establishment can be considered a "tip".

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    Is this answer based on an actual law, or are you just guessing?
    – bdb484
    Commented Aug 18 at 17:25
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    @bdb484, well I'm not from the US jurisdiction and I was writing off the cuff, but for the UK see "3 Definitions": gov.uk/government/publications/…
    – Steve
    Commented Aug 18 at 19:56

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