Is a service charge a tip? What US restaurants must tell guests, and the IRS

A guest photographs your receipt, posts it online and asks where the 20% "service charge" goes. The next morning a server asks whether it counts as their tip.

No. In the US a service charge is not a tip. The IRS treats a tip as money the guest chooses to give and sizes themselves. Any amount you add to the bill by policy, such as an 18% charge on large parties, is a service charge. Paid to staff, it is wages, not tips, and it does not count for the new "no tax on tips" deduction. Last checked: 4 November 2026.

Why are service charges in the news in 2026?

Two February 2026 stories show what is at stake when guests, staff and the law read a charge differently.

• Burdell, Oakland: a disclosure story. The San Francisco Chronicle reported on 14 February 2026 that a Reddit post of a Burdell receipt drew more than 1,500 comments. The restaurant has charged 20% since 2022 and says the charge funds about 40% of hourly payroll plus health care. One outlet first called it an "automatic 20% tip". The owner told the Chronicle the complaints turned "hostile and hateful".
• The San Francisco Hilton: a staff pay story. Bloomberg Law reported on 2 February 2026 that the hotel had agreed to a $12 million settlement with about 1,100 servers and bussers, who said their tips were disguised as "mandatory service charges". The settlement was filed in federal court for approval.

A clear policy prevents both.

Is a service charge a tip? The IRS four-factor test

The rule comes from IRS Revenue Ruling 2012-18, published in Internal Revenue Bulletin 2012-26. What you call the charge does not decide it: "The employer's characterization of a payment as a 'tip' is not determinative." The IRS looks at four factors, taken from an older ruling (Rev. Rul. 59-252). If any one is missing, the payment may be a service charge:

1. The guest pays it free from compulsion.
2. The guest has the unrestricted right to decide the amount.
3. The amount is not negotiated or dictated by employer policy.
4. Generally, the guest decides who receives it.

The ruling gives two restaurant examples:

• Service charge: a restaurant's menu says 18% is added to bills for parties of six or more. The amount appears on the tip line and is passed to waitstaff and bussers. It is still not a tip, because employer policy set it.
• Tip: a restaurant prints suggested amounts of 15%, 18% and 20% on the receipt but leaves the tip line blank. The guest writes in 15%. That is a tip, because the guest chose it.

An "automatic gratuity" fails the same test. Calling it a gratuity does not make it one. The 2026 Form W-2 instructions say it plainly: "Mandatory service charges added to the bill are not qualified tips."

Service charge vs gratuity vs tip: what is the difference?

A tip, also called a gratuity, is whatever the guest decides to leave. A service charge, including an "automatic gratuity", is an amount the restaurant sets and the guest has to pay. The difference follows the money all the way to the W-2.

Sources: the IRS fact sheet FS-2017-08 for the W-2 boxes, the 2026 W-2 instructions for code TP, and DOL Fact Sheet 15 for minimum wage and overtime.

The overtime row is the one owners miss. Fact Sheet 15 says service charge money you pay to an employee "must be included in the regular rate", so it raises the overtime rate for any week over 40 hours. Tips do not. An illustration: a server paid $18 an hour works 45 hours and receives $270 from service charges that week.

The service charge adds $15 to that week's overtime. For ten servers who regularly work 45 hours, that is $150 a week, or $7,800 a year, and payroll has to catch it. Our guide to restaurant scheduling laws covers the rest of the hours rules.

The FICA tip credit row matters too. The credit applies only to tips, and the IRS instructions for Form 8846 send you to Rev. Rul. 2012-18 for the line between tips and service charges. A service charge earns no credit. Our tip credit guide works through that credit.

Worked example: an 18% large-party charge plus a tip

A party of eight orders $480 of food and drink. Your policy adds 18% for parties of six or more. One guest also writes $20 on the card slip.

The server can use only the $20 toward their "no tax on tips" deduction. The $86.40 is taxed like any other pay. If the server works more than 40 hours that week, the $86.40 also goes into the overtime calculation. Our guide to no tax on tips covers the 2026 W-2 in full.

A tip prompt on a card reader is different. Under the final "no tax on tips" rules (published in the Federal Register on 13 April 2026), a suggested tip can still be a tip if the guest can lower it to zero, for example with a "no tip" button. A screen that makes the guest pick a tip amount before paying produces a mandatory charge, not a tip.

Can I keep the service charge, or must staff get it?

Under federal law, a compulsory charge is not a tip, so the rule that stops you keeping tips does not apply to it. DOL Fact Sheet 15 says money you distribute from a service charge counts toward your minimum wage and overtime obligations. A law-firm summary from Ogletree (30 December 2025) notes that federally an employer may keep all or part of a service charge.

Some states say otherwise, and guests' expectations matter everywhere:

• Massachusetts: under M.G.L. c.149 s.152A, a "service charge" or a vaguely described "service fee" must go entirely to wait staff, service employees and service bartenders. A separate "house fee" is allowed if it is clearly described as not going to staff. (Secondary: summaries of the statute page.)
• New York: the Hospitality Industry Wage Order (12 NYCRR 146-2.18) presumes that any charge beyond food, drink and lodging, including a charge called "service", is a gratuity for staff. You rebut it by telling guests, in plain words on the menu and the bill, that the charge is not a gratuity. Courts applying the rule for banquet charges (146-2.19) have held employers to a font no smaller than 12-point.
• California: the Labor Commissioner's tips FAQ says a service charge "may be considered a 'gratuity' (tip) under Labor Code section 350 or not", depending on whether guests perceive and intend it as one. A charge that reads like a tip can end up treated as one.

If you keep part of the charge, say so in the same place you show the charge. The Burdell story shows that guests will assume it all goes to staff unless you tell them otherwise. Check with an adviser for your situation.

What do you have to tell guests?

The FTC rule does not cover restaurants. The FTC's Rule on Unfair or Deceptive Fees took effect on 12 May 2025 and applies only to live-event tickets and short-term lodging.

State law decides how the charge is shown. California, Colorado, Connecticut, Florida, Massachusetts, Minnesota, Virginia and Washington set fee display rules today, and Illinois follows on 1 January 2027; our junk fee laws guide has each state's law, start date and display checklist. In California, restaurants are exempt from the hidden-fees ban as long as the fee "is clearly and conspicuously displayed wherever prices are shown", according to the Attorney General's guidance.

Two wage-law rules shape the wording itself. New York presumes a charge is a gratuity unless the menu and bill say in plain words that it is not. Washington's RCW 49.46.160, a statute in force since 2007, requires the menu and the itemized receipt to state the share of an automatic service charge paid to the employees who served the guest. Check with an adviser for your state.

Menu and receipt wording you can copy

One wording can usually satisfy the IRS test, California's display rule and New York's presumption at the same time. It names the charge as a charge, says it is not a tip, and says where the money goes.

For the menu, website and booking page, next to the prices:

A 20% service charge is added to every bill. It is not a tip.
It pays for [our team's wages, health care and kitchen staff].
[All of it / 70% of it] goes to the staff who work your shift.
Any tip you add is yours to choose and goes to the team.

For large parties only:

Parties of 6 or more: an 18% service charge is added to the bill.
This is a service charge, not a gratuity. Any extra tip is optional.

On the receipt:

Subtotal                         $480.00
Service charge (18%, not a tip)   $86.40
Sales tax                         $xx.xx
Total                            $xxx.xx
Tip (optional)                   _______

In Washington, add the percentage that goes to the employees who served the guest. In Colorado, describe how the charge is distributed. In New York, print the notice no smaller than the text around it.

Habits that cause trouble:

• Calling the line "gratuity" or "tip" on the receipt.
• Showing the charge only on the final bill, not where prices are shown.
• A tip screen with no zero option, which makes the "tip" a mandatory charge.
• Staff telling guests "it all goes to us" when it does not.

Tip or service charge? A test for every line on your bill

Run each charge, prompt and fee through this before it goes on a menu, a card reader or a receipt.

TIP OR SERVICE CHARGE?

1. Can the guest change the amount or remove it, down to zero?
   No  -> SERVICE CHARGE. Go to 3.
   Yes -> go to 2.

2. Did the guest choose it freely, rather than agree it in an event
   contract or have it set by house policy?
   Yes -> TIP. Report it as tips on the W-2; it can count for
          "no tax on tips" and your FICA tip credit. Share it under
          your tip pooling rules. Stop.
   No  -> Treat it as a SERVICE CHARGE. Go to 3.

3. Name it "service charge" (never "gratuity" or "tip") on the menu,
   website, booking page and receipt, with what it pays for.

4. Where does the money go?
   Paid to staff -> wages: W-2 Boxes 1, 3 and 5, and in the overtime
                    regular rate.
   Kept, in part -> say what share staff get, where the charge is shown.

5. Check your state's display rule. In MA, NY or WA, also apply
   the payout or wording rule above.

For step 2, our tip pooling guide covers who can share real tips.

Can TablePort handle this for you?

TablePort covers the tip side of this test and the numbers your accountant needs.

1. Set your own tip prompts on the card reader, and choose whether the kiosk and QR order and pay show a tip screen. Keep a zero option on each.
2. At close, cash, voids, comps and tips reconcile on one screen, and the daily report shows tips per staff member.
3. Use the accounting exports to give your accountant daily sales, tips and tax, and sync sales to QuickBooks or Xero.

One honest limit: TablePort does not run payroll and does not write your menu wording. How the service charge is taxed, shared and disclosed stays your decision, with your accountant. See the POS page.