Service charge vs Tip: What is the difference?

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Understanding service charge vs tip will save you headaches when filing your finances with the Internal Revenue Service (IRS).

Service charges and tips are ways customers thank you for service delivery and are probably a company’s favorite topping for a business transaction.

Although both are often mistaken to be the same, the IRS defines automatic gratuities as service charges, not tips. You should know the difference and how to report each.

So,

What is a service charge?

Service charges are a compulsory and often fixed payment a customer makes to a business for service delivery.

Service charges are common in the hospitality sector, with the payment usually pre-determined.

Examples of service charges include hotel room service charges, banquet event fees, large dining parties, cruise trip package fees, bottle service charges, or banquet event fees.

Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages.

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What makes a payment a service charge?

A business can consider certain payments as service charges when:

The payment isn’t optional
The customer can’t determine the amount paid
The payment receiver is fixed and not determined by the customer
The fee isn’t negotiable by the customer

What are tips?

Tips are voluntary payments a customer makes to your business or employee. The customer determines the amount.

Tips could be received directly from the customer in cash or through electronic payment that includes a credit card, debit card, gift card, or any other electronic payment method.

There are also non-cash tips, such as tickets or tips distributed through tip pools (formal or informal arrangements).

What makes a payment a tip?

The following factors can help you tell the tip vs service charge differences.

You consider payments as a tip when:

The payment is optional and free from compulsion
The customer determines the amount paid
The payment is not subject to negotiations or dictated by the business or employee
The customer has the right to decide who receives the compensation.

If the cash meets the above factors, it is a tip.

What does gratuity mean?: Gratuity is an optional payment in which the customer determines the amount paid. It's a tip.

Reporting service charges

Your company should treat these payments as regular income, as the IRS requires. If a percentage of service charges goes into employee salaries, then this should be noted in your payroll system and added to their net pay.

According to the IRS, businesses that distribute service charges to employees should treat them the same as regular wages for tax withholding and filing requirements.

For further information on reporting service charges and tips, you can advise your employees to review the IRS Publication 531 fact sheet, which outlines tip income reporting requirements.

Reporting tips

Employees must report any cash tip equal to or greater than $20 within a month to the employer in a written statement.

Cash tips include tips from customers, charged gratuities (credit and debit card charges) distributed to the employee by their employer, and tips from other employees under any tip-sharing arrangement.

It’s not mandatory for employees to report non-cash tips from customers. As such, the reporting format only accounts for the non-cash tip date along with the total.

However, you should add all cash and non-cash tips an employee receives to their gross income, subject to Federal income taxes.

When reporting tips, there is no particular form; however, the statement must include:

Employee signature,
Employee’s name, address, and social security number,
Employer’s name and address (establishment name if different),
Month or period the report covers, and
Total of tips received during the month or period.

The employee may use any document with the above elements, such as Form 4070, Employee’s Report of Tips to Employer (available only in Publication 1244), a form provided by the employer, or an electronic system provided by your employer to report your tips.

Both directly and indirectly, tipped employees must report tips to the employer.

Final thoughts – service charge vs tip

You’ve understood that service charges and tips are not interchangeable. While service charges are fixed and compulsory payments, tips are optional.

However, both are taxable.

Akaunting helps you streamline your Payroll processes and manage service charges for appropriate tax filing. You also save time on running your day-to-day business operations without stressing out.

Service charge vs Tip FAQs

Is service charge a tip?

No. Service charges aren’t the same as tips. The former is compulsory, while the latter is voluntary and solely depends on the customer.

Are service charges and tips taxable?

Service charges and tips are taxable, and you should report both accordingly.

Are tips and service charges taxed differently?

The IRS taxes Tips and Service charges the same as regular wages.

When are tips reported to the employer?

According to the IRS, employees must report tips no later than the 10th of every collection month. For example, if an employee received tips in August 2020, they should report to the employer on or before September 10, 2020.

What is a standard tip percentage?

There is no official tip percentage. However, tips are generally between 15-20% of the pre-tax bill.

How much should you tip a waitress?

The commonly used tipping percentage of waiters or waitresses is 15 to 20 percent of the pre-tax bill.

How much to tip on takeout?

Pre-pandemic time, the industry standard for tipping takeout orders was 10%. However, this increased to 15% before the tax bill.

Is service charge the same as gratuity?

Service charge isn’t the same as gratuity. Gratuity is voluntary payment customers make to a business. It is also known as a tip.