Multi-State Tax Law Blog
In the United States, tipping at restaurants is never really optional. While customers are the ones who write in a tip on their bills at their discretion, it is generally expected to leave 15-20%. Occasionally when large parties visit a restaurant, a mandatory tip is imposed by the restaurant on the bill. This ensures that servers, who may dedicate a large portion of their shift to a particular party, do not leave empty handed.
But when a tip is mandatory, is it really a tip? Or is it actually part of the food price? This was the question addressed by the Idaho Supreme Court. While tips are generally not taxable, restaurant food is taxable. When a tip becomes requisite payment for restaurant food, it becomes no different in substance than the sales price on the menu. As a result, if mandatory tips are, in fact, part of the sales price, then they too are subject to tax. Yes, that means you have to pay tax on the tip.
While the consequence of paying tax on mandatory tips only adds a small amount to the total bill, the cumulative effect can be substantial on the restaurant. This was the experience of an Idaho restaurant, Chandlers’-Boise LLC, that was found liable for sales tax on the amounts it automatically added to customer checks. The restaurant, which added gratuity to parties of six or more, argued in Chandler’s-Boise, LLC v Idaho State Tax Comm’n. 398 P.3d 180 (Idaho 2017), that such tips were exempt under Idaho law.
Specifically, Idaho Code section 63-3613(b)(4) exempts certain charges from the “sales price” that is subject to tax. Included in the exemption are amounts charged for labor or services rendered in installing or applying the property sold, as long as that amount is separately stated. Further, Idaho Code section 63-3613(b)(6) exempts the amount charged for finance charges, carrying charges, and service charges. Finally, IDAPA Rule 35.01.02.11.02 (2010) excluded voluntary tips from the taxable “sales price.”
The Taxpayer believed mandatory gratuity fell under all, or at least one, of these laws. However, the Idaho Supreme Court disagreed. According to the Court, the Idaho Code exemptions are to be narrowly construed and do not include mandatory gratuity in restaurants. In support of this was the fact that the section applied only to service charges related to contractors and the financial industry.
The IDAPA Rule was amended in 2011 to state that the sales price “shall not include a gratuity or tip received when paid to the service provider of a meal. The gratuity or tip can be either voluntary or mandatory.” However, this amendment occurred after the audit and court found that the 2011 amendment of IDAPA Rule 35.01.02.11.02 (2011) did not apply because it was not retroactive to the audit period.
Much ado was made about the change between 2010 and 2011. Previously, in 2010, gratuities that were voluntary were exempted while gratuities that were mandatory were not. However, in 2011, the rule was amended to eliminate the distinction between types of gratuities and exempt all gratuities. The Taxpayer tried to argue that the amendment simply clarified the previous rule and that mandatory gratuities were always exempt. However, the Department and Court found that it was a change, and the exemption of mandatory gratuity fees was enacted after the audit period, which was from 2007 through 2010.
Across the country, it is vitally important for restaurant owners to understand states’ varying perspectives of mandatory gratuities. While Idaho now exempts all restaurant gratuities, that is certainly not the case in all states. As the gratuity itself goes to the server, the restaurant owner generally does not make any money off of the tip but unfortunately can be held liable for the tax on it. Consequently, it is important to plan properly to avoid an assessment like the one Chandler’s was stuck with.
Jeanette Moffa is an attorney who concentrates on state and local taxes at Moffa, Sutton, & Donnini, P.A. She is also an adjunct professor and assistant editor to the American Bar Association’s The Sales and Use Tax Deskbook. She can be reached at 954-800-4138 or JeanetteMoffa@FloridaSalesTax.com