The Death of the Auto-Gratuity?

A new tax rule has cocktail servers fearing the worst

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Every Las Vegas nightclub server knows the beauty of the automatic gratuity. That $500 bottle of Grey Goose that gets a 20 percent auto-grat is the key to a far better living than pushing crab specials at Red Lobster. But an IRS ruling going into effect January 1 may have some nightclubs considering doing away with auto-grats altogether.

In 2012, the IRS came to the conclusion that many automatic gratuities are not really gratuities, but rather service charges, largely because the customer doesn’t really have a “choice” whether to leave the gratuity or not. So as of January 1, that common automatic tip for bottle service in a nightclub or for large parties at a restaurant will now be considered a service charge.

Kelsey Canepa, a local nightclub server, is very curious about the 2014 changes. “People in the industry have been mentioning it, but no one really knows the details,” she says. So what does this really mean for servers?

First, they will need to wait for that money to come on a paycheck instead of taking the cash home that night. The money will be taxed as a wage instead of a tip, which brings no added tax burden for the server. But there is a behind-the-scenes impact from this seemingly small change that could get ugly.

Because a service charge must be recorded as a wage, restaurants and clubs lose out on Medicare and Social Security tax credits that came from money that was logged as a tip. Plus, payroll paperwork gets complicated, as this new wage money needs to be factored into an hourly wage that will fluctuate weekly based on the number of these new service charges reported.

These changes are already creating a headache for large restaurant operators. In a September Wall Street Journal report, Darden Restaurants Inc., which owns Olive Garden, Red Lobster and LongHorn Steakhouse, said it was testing a “suggested tip” system by including the figures for a 15, 18 and 20 percent gratuity, but leaving the actual gratuity line blank. The company will make a final decision by the end of the year as to whether it will do away entirely with automatic gratuities at its 2,100 restaurants.

Some New York restaurants are even working to do away with tips entirely, instead simply slapping higher prices on plates that include a service fee to cover a higher hourly wage for servers. Similar moves have been made by restaurants in California to cover costs associated with the Affordable Care Act, says Jeff Breeden, a partner with local accounting firm Stewart, Archibald & Barney.

Changes like these in Las Vegas nightclubs would surely have an impact on income for servers heavily reliant on these high-dollar auto-grat scenarios, Breeden says. “If [automatic gratuity] is a large percentage of your income, then it would mean something. Some people just don’t want to [voluntarily] leave a $40 tip.”

Locally, nightclub operators have been quiet on the issue. Representatives for the Light Group, Angel Management Group and the ONE Group didn’t respond to inquiries, while Tao Group issued the following statement on the matter then declined any further comment: “Tao Group will of course follow all IRS regulations and do our best to be as fair as possible to all involved while complying with the law.”

Although tight-lipped, club operators are clearly weighing the impacts. But cocktail server Canepa is more concerned about clubs doing away with automatic gratuities. “That would be huge. That’s a game changer for a lot of people,” she says. “Those servers would go from making good money to making the same [as] at any restaurant.”

With no disrespect to Darden Restaurants, 2014 may be the year some local nightclub servers end up looking for the seafood lover in us after all.

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