Mandatory tips and gratuities are generally subject to sales tax in California when:
• An amount is automatically added to the bill without first consulting with the customer after the meal is served. Think about group meals, banquets, etc. Generally when serving more than 8 at one table in one ticket.
• The customer and the business agree to a suggest tip amount before the service or event. Think preplanned gathering, education meeting with a meal, conference, etc.
• Menus, brochures, ads, or other materials state that tips, gratuities, or service charges will automatically be added to the bill. Not unusual on many restaurant menus these days.
However, tips and gratuities are generally not taxable when the customer voluntarily adds a separate amount to the bill, and the amount is distributed to the business’ employees.
Examples include:
• When the check or bill has a blank “tip” area for customers to voluntarily write in an amount.
• When the check or bill suggests tips computed for the customer, but the “tip” area is left blank for the customer to voluntarily write in an amount.
This becomes an issue for restaurant owners because they might end up getting taxed on the customer tickets, which they are supposed to keep for for audit purposes, are not kept or don’t distinguish between food and services and tips. Upon audit they might get hit with the tax on the whole gross income (including tips).
For the consumer this is important because adding the sales tax on tips can add up.
Example:
You are planning a conference at which you are going to supply the meals for the attendees. You expect 400 people to show up at the cost of $25 per meal. The restaurant requires an 18% gratuity on top of the price of meals.
Cost of Meals = $25 x 400 = $10,000
Sales tax on Meals @ 8% = $800
Gratuity on Meals = $10,000 x .18 = $1,800
Expected cost: $12,600
Actual bill
Cost of Meals = $10,000
Cost of Gratuities = 1,800
Sales Tax on $11,800 = 944
Actual bill = $12,744
The additional cost due to California’s taxing scenario $144.00
This might not seem like much but do this conference ten or fifteen times a year and it adds up quickly. Sales taxes are generally not deductible for income tax purposes. So that increases the effective tax even more.
Original Post By: Steven Potts
An Enrolled Agent and U.S. Tax Court Practitioner, I represent taxpayers in front of the IRS and the U.S. Tax Court on self-prepared tax returns and tax returns prepared by other tax preparers. I handle CDP hearings, collection cases and contested issues in IRS audits. With more than three decades of experience working with small individual returns to large, multi-company and multinational companies returns I have a broad breadth of experience and am in the position to help you.
As an Approved Continuing Education Provider, I am available to speak to organizations throughout the United States on Tax and Tax Research issues.
1 comment on “Are Tips Taxable?”
Steven – great concise summary so much appreciated as an IL CPA / EA that moved to San Diego just 3 years ago (1st time ever in CA !).
Anyway, wondering about food, drinks, and mandatory service charges at a conference where the sponsor is a non-profit organization – would exemption from sales tax apply with the proper documentation – if so, which state agency is involved to obtain exemption certificate ?
Also, what about “ancillary” services provided by the conference center such as projection equipment or other technical services such as a satellite feed that are treated as separate additional charges ?
Thanks for your feedback !
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