Is your Gratuity policy costing you money?

By John Marshall

Operators know that there are times when a tip is indirectly proportional to the number of customers.  Put another way, at some point, as the size of a group grows, the tip will begin to  shrink as a percentage of sales. Gratuities are often set by the house to ensure that servers are not left with a lower amount from a larger group than they would otherwise collect in tips from individual patrons.

What many establishments may not have considered is that there are certain situations, dictated by tip program policy, which can make the decision to implement or maintain a house gratuity policy a financial mistake.

One of the goals of a typical restaurant is to minimize the cash/charge tip rate gap in order to stay under the IRS radar screen. Often a POS will combine gratuities with tips because these have both traditionally been paid out together to servers at the end of each shift. When using a tip policy management package such as GrataSoft, the software will remove gratuities and the associated receipts from gross sales and tips as required by the IRS. The effect of this will typically lower the charged tip rate, as gratuities are often higher in terms percentage of sales than tips. This can be to an operator’s advantage in two ways; lower charge tip rates lessen the cash/charge tip gap, and in the case of ATIP participants, a lower charged tip rate equates to a lower ATIP target rate used to calculate and attribute tips to staff.

Let’s consider the example of an ATIP participating firm. As we know from (How ATIP can save you money), there are certain instances such as high charge receipts when it can be in an operator’s best interest to participate in the ATIP program as a legitimate means of reducing total tips declared. Recall that the ATIP target rate is set two percentage points below the facility’s previous year charged tip rate. A restaurant that had an 18% charged tip rate in its previous year has an ATIP target rate of just 16% this year. The ATIP advantage for high credit establishments is that the IRS immediately gives you a 2% reduction in tip declarations against actual charged tips received! Many have discovered that this is a really sweet deal. With this in mind, why then would an operator choose to maintain a house gratuity policy that is set at 20% of receipts and paid as wages when she has the opportunity to throw it out and switch all patrons to a tip scenario and enjoy a 4% immediate overall savings? There may be some downside. There is the potential for your house tip rate to be influenced up slightly, but just as likely is the scenario where switching larger groups to tips will cause a reduction in tip rates compared to the gratuity rates. In this instance, the house charged tip rate may remain virtually the same. This hypothetical restaurant noted above with $200,000 in gratuity sales could reduce tip declarations by $8000 simply by tossing out their gratuity policy.

I need to caution operators however that in IRS audit situations, establishments have been cited and levied for gratuities not being paid out as wages.  To eliminate ones gratuity policy without considering the downside risk would be shortsighted.  If one were to rely on an automation tool to ensure that all gratuities (paid as tips) were in fact declared, the issue may be moot.

Now that the Tip Credit may be applied toward AMT, I have been asked if paying gratuities as wages effectively reduces the tip credit by the same amount.  The answer depends on your payroll provider and the wage of the employee.  If the server is paid the traditional $2.13/hr, it is unlikely that their wages plus gratuities would exceed minimum wage.  Make sure payroll providers are aware of, and consider all wages when calculating the minimum wage threashold.  Be sure also to ensure that this value remains fixed at $5.15/hr (as approved), ignoring the Federal Minimum wage increases scheduled over the next few years.