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IRS Reminders Affecting Income and Sales Tax

The IRS has issued a fact sheet reminding employers that automatic gratuities” and similar charges imposed on the customer are service charges, not tips. This distinction is important for both income and sales tax purposes. For example, tips are reported differently than service charges for income tax purposes, and in Wisconsin, generally service charges are subject to sales tax but tips are not.

The fact sheet states that the following four factors all normally must be met for a payment to qualify as a tip:

  • The payment must be made free from compulsion;
  • The customer must have the unrestricted right to determine the amount;
  • The payment should not be the subject of negotiations or dictated by employer policy; and
  • Generally, the customer has the right to determine who receives the payment.

If any one of these does not apply, the payment is likely a service charge.

The fact sheet also provides information on income tax reporting requirements for tips and service charges. See FS-2017 – 08

For additional information from the Wisconsin Department of Revenue on when gratuities are subject to sales tax, see here

DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.

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