The IRS Viewpoint on Tips

The IRS doesn’t treat mandatory gratuity as a tip.

While tipping is not mandatory in most of the U.S., it is often expected in many circumstances when services are provided. The tip income from services—whether cash or included in a charge—is taxable income. As taxable income, these tips are subject to federal income, social security and Medicare taxes, and may be subject to state income tax as well.

Employees who receive $20 or more in tips in any one month should report all tips to their employer; however, all tips are taxable income and should be reported on the employee’s tax return. The employee should maintain records of tip income. The IRS provides Publication 1244, Employee’s Daily Record of Tips and Report to Employer, for substantiation in the event of an audit.
 
Beginning back in  January 1, 2014, the IRS defined tips as follows:

1. The gratuity must be made free from compulsion;
2. The customer must have the unrestricted right to determine the amount;
3. The gratuity should not be the subject of negotiation or dictated by employer policy; and
4. Generally, the customer has the right to determine who receives the gratuity.

The IRS now treats automatic gratuities on restaurant bills as wages and not tips. Automatic gratuities are often placed on bills of large parties to prevent under-tipping. The IRS views this as the latest step in the effort to prevent underreporting of tip income.