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I am asking this question in relation to recent talk about exempting tipped wages from income tax. This is something that seems to be supported by both Kamala Harris and Donald Trump in their presidential campaigns this year.

No tax on tips: Why politicians love it, and economists don't

When it comes to tips is there anything specific that makes it a tip or would disqualify it from being called a tip? This is being asked due to the practice that some businesses have of adding a "mandatory" tip to the bill for various reasons such as the number of people in the party.

For the purpose of tax law today are/can these mandatory charges classified as tips or as something else?

Joe W
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From the IRS website:

Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers.

Further down, the following criteria are given:

Q&A 1 of Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:

  • 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 negotiation or dictated by employer policy; and,
  • Generally, the customer has the right to determine who receives the payment.

Pooled tips count as tips, but "auto-gratuities" that many restaurants add for large parties do not.

Barmar
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The mandatory service charge would be considered a "controlled tip" and is considered salary for Canadian tax purposes.

Both controlled and direct tips receive the same ultimate tax treatment.

The main difference between a mandatory service charge (a controlled tip) and an optional add-on by the customer is that the mandatory service charge carries withholding and reporting obligations for the employer (e.g. for pension and employment insurance).

Regardless, all tips, gratuities, and salary received due to controlled tips must be included in a person's reported income each tax year.

As for hypothetical future laws, they could easily be written to exempt all tips including "controlled/mandatory tips" from taxation, or only direct tips, or no tips. One possible dividing line, if desired, is whether the employer/establishment mandates the fee and controls its distribution.

Jen
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I imagine a pretty universal criteria for a "tip" is that it is not a charge quantified by the establishment, or for which payment is called by the establishment.

So a "tip" called for on the bill is not a tip, but a service charge.

Not being quantified by anyone other than the payer, by definition it is also not mandatory. It is a gratuity, which would not be received in every transaction or at any minimum level.

I don't see how any mandatory charge enforced by the establishment can be considered a "tip".

Steve
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