The Internal Revenue Service (IRS) has clarified that only voluntary tips given by customers are exempt from taxation under new federal provisions. Mandatory tips, such as those imposed by some restaurants for large parties, do not qualify for this exemption.
In a statement released on September 28, 2023, the IRS indicated that “qualified tips must be paid voluntarily by the customer and not be subject to negotiation.” This means that if a customer cannot modify or refuse a tip, it should not be considered deductible from the employee’s taxable income.
Restaurants commonly add an automatic gratuity, typically around 18%, for larger groups. This practice has drawn scrutiny, particularly in cases like a recent incident in Cupertino where a restaurant charged an 18% tip for “parties of 1 or larger.” Such mandatory charges will not receive the same tax treatment as voluntary tips under the new guidelines.
Federal legislation enacted in July 2023 allows workers in specific occupations to deduct up to $25,000 in tips from their reported income. This development aims to provide financial relief to those in industries where tipping is customary.
Recently, the IRS released a list of eligible occupations, identifying approximately 70 jobs where employees “customarily and regularly” receive tips. This includes various roles within the hospitality and service sectors, such as restaurant staff, hotel workers, gambling dealers, taxi and rideshare drivers, hairdressers, physical trainers, caddies, and “self-enrichment teachers.”
The clarification from the IRS is significant for both workers and employers as it delineates what constitutes a taxable tip. Understanding these guidelines will help affected individuals navigate their tax obligations more effectively.
For more detailed information, taxpayers may refer to the IRS fact sheet on the “No Tax on Tips” provision.
