Tips and Service Charges in the UK and USA – Clearing the Fog
With expert input from professional practitioners, HOSPA has produced a practical guide to Tips, Gratuities, Service Charges and Troncs for the UK Hospitality Industry.
It covers explanations of the terminology and details of the range of regulations, practices, options and consequences that affect UK hospitality businesses.
There has always been a big gap between perception and reality with this subject. The fact that there are no standard practices and differing if well-intentioned interpretations, inhibits progress towards developing an acceptable solution for all parties. Coupled with often conflicting tax and pay regulations, an ideal situation can only happen if the industry works together with the tax authorities and government to create a more level playing-field.
In the short term there might be winners and losers, but there is a growing necessity for the industry to rid itself of negative and outdated practices if it is to be able to compete for its growing workforce’s needs in a rapidly shrinking employment market.
The HOSPA guide provides essential factual information for decision making and formulating policies. This will facilitate development of best practices that recognise the complexity of the regulations and taxation issues that affect considerations of practicality and fairness for the public, employees and employers.
Aspects of how tips and service charges are accounted for and reflected in hospitality businesses performance measures is a subject for further review. It is clear that a variety of accounting practices exist and most do not adequately reflect what is actually happening.
Prior to addressing this subject, it seems worthwhile to review how these items are dealt with in the USA. This is where the most common management accounting standards used within the industry have originated, specifically the Uniform System of Accounts for the Lodging Industry.
Perhaps it should not be a surprise that the subject seems to be even more complicated there than in the UK. There are regulations that are national, but many of the states have overlaid these with their own or union negotiated variations.
Some of the key practices in the US and how they contrast with the UK follow:
1 To be considered a tip, the criteria to be met are:
• the payment is made by the customer free of compulsion
• the customer has the unrestricted right to determine the amount
• the payment is not subject to negotiations or the policy of the business; and
• the customer has the right to determine who receives the payment (albeit that there may be pooling arrangements among the employees)
• ‘automatic gratuities’ are not considered by the IRS as tips. They or any other similar charge imposed on the customer are treated as service charges. Any service charges paid to employees are treated as non-tip wages
So-called discretionary service charges imposed by the employer, commonly used in the UK to avoid VAT, are not considered to be the same as tips by the IRS in the US.
2 Employees who customarily receive tips, and more than $30 per month, are categorised as ‘tipped employees’. Employees with direct contact with customers are ‘directly tipped employees’ and those whose roles are supporting the service such as table clearers and cooks are considered ‘indirectly tipped employees’.
Under the Fair Labor Standards Act employers may charge a fee of up to 3% of charged tips where credit card charges have been incurred.
In the UK there is no legislation covering employer deductions from tips or service charges, but union and consumer pressure leans towards a limit of around 5%.
3 Tipped employees have to pay tax, Social Security and other payroll related charges on their total earnings including tips. Although tips whether pooled or not are in effect controlled by the staff, individual earnings have to be reported to their employer.
This means that, unlike in the UK where only income tax applies, there are no advantages in terms of net pay from receiving part of their earnings as tips or via a tronc.
4 The same rules apply to both direct and indirect tips in respect of taxes and related charges. These are laid down by the Internal Revenue Service (the US equivalent of our HMRC). They require tip income to be reported by the employee to the employer, who is then required to apply both employee and employer contributions to income tax, Social Security and Medicare.
There is no exemption for the employer from these charges as there would be in the UK on employee tip earnings or tronc distributions.
5 Employers in the USA can therefore see exactly what each tipped employee earns from tips.
In the UK, employees are responsible for declaring their own tip income to HMRC. These earnings are therefore invisible to employers.
6 The US national minimum wage is currently $7.25 per hour. If an employee’s wage and tips do not equal this over a month, the employer must make up the difference in the cash wage. In any event, the employer must pay at least $2.13 an hour in the form of cash wage. Tips can and do form part of the minimum wage. This is one of the reasons that one hears of restaurant customers in the USA being chased down the road by servers demanding their tip!
In the UK no part of minimum wages can be paid out of tips or service charges.
Searches on the Internet including the US IRS web site formed the basis of the above. If the subject is of importance to your business it is recommended that you seek appropriate professional advice. A future article will look at the accounting implications of tips and service charges, including their impact on performance measurement and benchmarking.
Howard Field FCA FHOSPA FIH firstname.lastname@example.org August 2018