California Makes Treatment of Tips and Gratuities Consistent with Records Kept for IRS

Effective January 1, 2015, California has amended a sales and use tax regulation regarding taxable sales of food products to make the regulation’s treatment of tips, gratuities, and service charges consistent with the records retailers keep for reporting such payments as tip wages or non-tip wages for Internal Revenue Service purposes. The amendments add a new presumption regarding whether a tip, gratuity, or service charge is subject to tax based on such records. An optional payment designated as a tip, gratuity, or service charge is not subject to sales tax. A mandatory payment designated as a tip, gratuity, or service charge is included in taxable gross receipts, even if it is subsequently paid by the retailer to employees. Per the updated agreement, for optional payments, when a retailer keeps records consistent with reporting amounts as tip wages for IRS purposes, such amounts are presumed to be optional and not subject to tax. When a retailer does not maintain such records, this presumption does not apply and the amounts may be mandatory and included in taxable gross receipts. If an employer misappropriates these amounts, such payments are included in the retailer’s taxable gross receipts. Per the updated agreement, for mandatory payments, when a retailer’s records reflect that amounts are required to be reported to the IRS as non-tip wages, the amount is deemed to be mandatory. When a retailer does not maintain records for purposes of reporting the amounts to the IRS:

  • An amount negotiated between the retailer and the customer in advance of a meal, food, or drinks, or an event that includes a meal, food, or drinks is mandatory.
  • When the menu, brochures, advertisements or other printed materials contain statements that notify customers that tips, gratuities, or service charges will or may be added, an amount automatically added by the retailer to the bill or invoice presented to and paid by the customer is a mandatory charge and subject to tax. These amounts are considered negotiated in advance.

An amount will be considered “automatically added” when the retailer adds the amount to the bill without first conferring with the customer after service of the meal. Nonetheless, any amount added by the retailer is presumed to be automatically added and mandatory. It is presumed that an amount added as a tip by the retailer to the bill or invoice presented to the customer is automatically added and mandatory. A statement on the bill or invoice that the amount added by the retailer is a “suggested tip” “optional gratuity” or that the amount “may be increased, decreased, or removed” by the customer does not change the mandatory nature of the charge. This presumption may be controverted by documentary evidence showing that the customer specifically requested and authorized the amount be added to the bill. The retailer must retain the guest checks and any additional separate documents to show that the payment is optional. (Reg. 1603, California State Board of Equalization, effective January 1, 2015)

Posted on December 29, 2014