Service charge

Service charge vs tip: what's the difference?

A tip is the guest's choice. A service charge is the venue's. The IRS (Fact Sheet 2015-8) treats a payment as a tip only when four things are true. If any one is missing, the payment is likely a service charge, and what the employer or employee calls it is not determinative.

• The guest pays it freely, without compulsion.
• The guest has the unrestricted right to set the amount.
• The amount is not negotiated or dictated by employer policy.
• The guest generally decides who receives it.

Who keeps a service charge?

The business. Under the federal Fair Labor Standards Act, the U.S. Department of Labor says a compulsory charge, such as 15 percent of the bill, is not a tip. The employer may use amounts it pays out from the charge toward its minimum wage and overtime obligations, and must include them in the regular rate used to work out overtime. Real tips are different: employers, managers and supervisors may not keep them.Many venues pay part of a banquet service charge to the servers, bartenders and catering attendants who worked the event, based on house policy or a union contract. Federal law does not require it.

How is a service charge taxed?

Service charge money paid to employees is non-tip wages. The employer withholds income tax, Social Security and Medicare, and the amount appears in W-2 wages like regular pay. If the employer keeps part of the charge, only the part paid out counts as the employee's wages (IRS FS-2015-8). Tips, by contrast, are reported by the employee to the employer and show in Box 7 (Social Security tips) of the W-2.For the federal "no tax on tips" deduction (tax years 2025 to 2028), payouts from a mandatory service charge are not qualified tips. Only tips guests chose to give count. See how service charges affect the tips deduction.

State rules on service charge disclosure and distribution

Some states go further than federal law, especially for banquets. Check your state's labor department for the rules where the event takes place.

• New York: in Samiento v. World Yacht (2008), the state's highest court held that a mandatory banquet charge can be a gratuity under Labor Law 196-d if a reasonable customer would believe it goes to staff. In hospitality, regulation 12 NYCRR 146-2.18 presumes a charge for "service" is a gratuity unless the employer clearly tells the customer it is not.
• California: Labor Code 351 bars an employer from taking a gratuity left for an employee. In O'Grady v. Merchant Exchange Productions (2019), a state appeals court held that a mandatory 21% banquet service charge is not automatically excluded from being a gratuity; the facts and what customers understood decide it.
• Other states and cities: disclosure rules for service fees and whether the charge is subject to sales tax vary. In many states a mandatory service charge is taxable as part of the sale, while a voluntary tip is not.

Service charges in catering and banquet contracts

Hotels, venues and caterers usually add the service charge as a percentage of the food and beverage total, often around 20%, and list it on the BEO and the final invoice, sometimes beside a separate administrative fee. It can apply to the menu, a hosted bar and rentals. The contract should say what the charge covers, whether any of it goes to the staff who work the event, and whether sales tax applies to it. If it does not, ask the venue to put the answer in writing.