Rev. Rul. 66-74

Advice has been requested whether amounts which a club collects through mandatory charges added to its members' bills and which it subsequently disburses to its employees with their wages may be treated by the club as tips for purposes of the Federal Insurance Contributions Act and the Collection of Income Tax at Source on Wages (chapters 21 and 24, respectively, subtitle C, Internal Revenue Code of 1954).

The club in the instant case operates on a charge basis only and does not permit direct tipping. Its members are billed for services, and mandatory `gratuities' are added. The `gratuities' are then disbursed with the employees' wages. The club has in the past treated the `gratuities' as service charges subject to all the Federal employment taxes, including income tax withholding. The question presented requires a determination under the provisions of the Internal Revenue Code as amended by section 313 of the Social Security Amendments of 1965, Public Law 89-97, July 30, 1965, C.B. 1965-2, 601, at page 606, whether the club may now treat the `gratuities' as tips, and whether the club is thus relieved from liability for the employer taxes imposed by the Federal Insurance Contributions Act.

The Internal Revenue Service has consistently differentiated tips or gratuities paid directly and voluntarily to an employee by a customer of the employer from so-called `gratuities' which actually are mandatory charges added to a customer's bill. Under rulings heretofore published, a mandatory charge added to a bill is not a tip or gratuity.

In S.S.T. 145, C.B. 1937-1, 443, the Service held that where a club does not permit the tipping of employees but in lieu thereof adds 10 percent to the cafe charges against its members' accounts and disburses the added amounts monthly to the club's waiters, the sums so disbursed are wages. The addition of the 10 percent is an arbitrary charge set by the club which the member must pay. The amount is clearly, therefore, not a gratuity.

In Revenue Ruling 57-397, C.B. 1957-2, 628, the Service held that amounts which customers are required to pay to a hotel as service charges for using the hotel's dining facilities and which the hotel later disburses to its waiters and other employees are wages for Federal employment tax purposes. The customer has no choice in the matter, and for that reason the amount is not a tip or gratuity.

In Revenue Ruling 59-252, C.B. 1959-2, 215, the Service amplified Revenue Ruling 57-397 to state that where negotiations between a hotel and a customer for the use of the hotel's banquet facilities are not restricted to the cost of meals and beverages but also include or contemplate additional amounts for distribution to employees of the hotel, then the amounts so distributed are not tips or gratuities but are wages for Federal employment tax purposes, including income tax withholding. The Revenue Ruling stated further:

To constitute a `tip' in the commonly accepted meaning of the term, it is inherent in the nature thereof that certain fundamental characteristics be present. It must be presented by the customer free from compulsion; he must have the unrestricted right to determine the amount thereof; and such amount should not be the subject of negotiation or dictated by employer policy. Generally, the customer has the right to determine precisely who shall be the recipient of his generosity. The absence of any of these factors creates a serious doubt as to whether the payment is really a tip and indicates that it is in fact a service charge for the use of certain facilities.

Tips or gratuities paid before 1966 directly to an employee by a customer of an employer and not accounted for by the employee to the employer, although includible in the employee's gross income, were not wages subject to the Federal employment taxes. Under section 6053(a) of the Code, an employee who receives cash tips amounting to $20 or more in any calendar month after 1965, in the course of his employment by an employer, must report the tips to the employer by furnishing one or more written statements not later than the 10th day following the month of receipt. The employer must withhold the employee taxes under the Federal Insurance Contributions Act and the income tax on the reported tips from wages of the employee (other than tips) under the employer's control or from other funds made available for this purpose by the employee. Tips received after 1965 are not subject to the employer taxes imposed by the Federal Insurance Contributions Act.

The congressional intent with respect to the treatment on and after January 1, 1966, of so-called `gratuities' which actually are service charges of the type the Service has consistently held to be wages is expressed in the Conference Report on Public Law 89-97 (H. Rept. 682, 89th Cong., C.B. 1965-2, 771, at page 778) as follows:

Under the conference agreement, the provisions of section 313 of the bill are to apply with respect to all tips received by employees after 1965 including those which under existing law would have been covered for social security tax purposes by reason of being accounted for by the employee to the employer. The provisions of section 313 of the bill, of course, do not apply to amounts which, although denominated tips, constitute wages under present law irrespective of whether accounted for by the employee to his employer.

Under the `present law' referred to in the Conference Report (that is, the law in effect before 1966), service charges collected from members or customers and distributed before 1966 to employees are wages, and not tips, under the rulings published in S.S.T. 145 and Revenue Rulings 57-397 and 59-252, referred to above. The charges continue to be wages, and not tips, under the Code as amended by the 1965 amendments. Accordingly, the club in the instant case may not treat the `gratuities' it collects, through mandatory charges, as tips for Federal employment tax purposes, and the club is not relieved from liability for the employer taxes. The club should continue to treat these amounts as service charges which are wages subject to both the employee and employer taxes under the Federal Insurance Contributions Act, to the employer tax under the Federal Unemployment Tax Act, and to income tax withholding.

The additions and amendments made to the Code by the provisions of section 313 of the Social Security Amendments of 1965 have no effect on S.S.T. 145, Revenue Ruling 57-397 or Revenue Ruling 59-252, referred to above.