Tax on Restaurant Service Fees

Restaurants across the country are adding service charges to customers’ checks to boost wages for back-of-house workers and remove discrepancies in tipping, but the US tax code favors traditional tipping systems through tax credits, while restaurants that charge service fees don’t receive a similar credit benefit.

Restaurants can only qualify for a tax credit under the standard tip system. Because the tip was passed to the employee who must pay income tax on that money, the restaurant can claim the tip tax credit against their federal income tax. The new service charge credit would apply only to payroll taxes, so only restaurants that use the service charge to pay employees a wage would be able to take the credit.

Rep. Earl Blumenauer, an Oregon Democrat on the House Ways and Means Committee introduced legislation (H.R.8401) to equalize the way the tax code treats service charges with tips. While the bill aims to bring tax parity between the two systems, it raises questions about whether restaurants with service charges should get a tax break at all.

While the federal minimum wage is $7.25 per hour, the rate for tipped workers is $2.13. Seven states plus the District of Columbia have phased out the subminimum wage, and several more are considering doing the same. Critics say the service charges reduce how much workers take home at the end of a shift. Labor groups and some restaurant owners prefer tips, which give customers more power and employees more control. Some critics say service charges reduce how much a server is taking home because the charge is spread among multiple workers, including cooks, dishwashers, and others in the back-of-the-house who already make at least the full minimum wage.

Depending on the state ta law, service charges may also be subject to sales tax that don’t apply to tips.