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North Carolina Restaurant and Lodging Association

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September 13, 2021

Service Charges

The federal Fair Labor Standards Act (FLSA) regulations describe the “general characteristics” of a tip as:

“… a sum presented by a customer as a gift or gratuity in recognition of some service performed for the customer. It is to be distinguished from payment of a charge, if any, made for the service. Whether a tip is to be given, and its amount, are matters determined solely by the customer, who has the right to determine who shall be the recipient of the gratuity”

(29 CFR § 531.52 – General restrictions on an employer’s use of its employees’ tips)

As expressed by North Carolina statute, “a tip shall not include a service charge which the employer requires the customer to pay, no matter what the charge is labeled” (12 NCAC 12.0303). Some restaurants choose to eliminate tips entirely and include a service charge or “auto gratuity” on the customers’ bills. Service charges are also used for banquets and, in some cases, large parties, in lieu of tipping. In short, service charges are treated as sales, not tips.

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

  • Cash tips received directly from customers
  • Tips left through electronic settlement or payment (including a credit card, debit card, gift card, or any other electronic payment method)
  • The value of any noncash tips, such as tickets or other items of value
  • Tip amounts received from other employees paid out through tip pools or tip splitting, or other formal or informal tip sharing arrangements

Four factors are used to determine whether a payment qualifies as a tip. All four factors must apply:

  • The payment must be given freely by the customer
  • The amount must be solely determined by the customer
  • The payment should not be the subject of negotiations or dictated by employer policy
  • Generally, the customer must have the right to determine who receives the payment

If any one of these does not apply, the payment is likely a service charge and is treated like any other sales revenue. Employers who distribute service charges to employees should treat them the same as regular wages for tax withholding and filing requirements. Employers should confer with an accountant for details.

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