Ask the Experts: Understanding Service Charges
By: Helen Lizzie Mills | Fahey Schultz Burzych Rhodes PLC
Q: How is a service charge different than a gratuity? What do I need to know before I implement a service charge?
A: Coming out of the COVID-19 pandemic, restaurants nationally have seen an increase in the use of “service charges,” or sums automatically added to a customer’s final bill. While generally permissible, it is critical to understand how the Federal Fair Labor Standards Act (FLSA) treats service charges compared to tips and imperative to clearly and accurately communicate to customers that a service charge will be added to their bill to avoid consumer-protection implications.
Under the FLSA, a “tip” is any sum presented by a customer as a gift or gratuity in recognition of a service performed, as opposed to a payment for that service. A customer’s discretion over whether to give that sum to an employee fundamentally distinguishes a “tip” from a “service charge. ”A customer is never required to give a tip. On the other hand, “service charges” – which may go by any number of different names – are imposed by the restaurant. For example, when a restaurant imposes a “mandatory” charge of 20% on tables of eight or more people, the mandatory gratuity is a “service charge” under the FLSA because the customer has no discretion over whether to pay the amount.
A: Coming out of the COVID-19 pandemic, restaurants nationally have seen an increase in the use of “service charges,” or sums automatically added to a customer’s final bill. While generally permissible, it is critical to understand how the Federal Fair Labor Standards Act (FLSA) treats service charges compared to tips and imperative to clearly and accurately communicate to customers that a service charge will be added to their bill to avoid consumer-protection implications.
Under the FLSA, a “tip” is any sum presented by a customer as a gift or gratuity in recognition of a service performed, as opposed to a payment for that service. A customer’s discretion over whether to give that sum to an employee fundamentally distinguishes a “tip” from a “service charge. ”A customer is never required to give a tip. On the other hand, “service charges” – which may go by any number of different names – are imposed by the restaurant. For example, when a restaurant imposes a “mandatory” charge of 20% on tables of eight or more people, the mandatory gratuity is a “service charge” under the FLSA because the customer has no discretion over whether to pay the amount.
Correctly identifying a paid sum as a “tip” or “service charge” is critically important for both restaurants and employees. Tips are the sole property of the employee(s)to whom they were given, and restaurants are strictly limited in the control that they may exercise over tips. Restaurants may not take from employees’ tips for required income tax withholding and may only exercise control over employees’ tips for distribution pursuant to a valid tip pool and to cover credit card fees incurred from employees’ credit card tips. On the other hand, service charges are income to the restaurant (even if later paid100% to the employees), are subject to restaurants’ income tax withholding obligations, and, under the FLSA, may be used for any reason at all, at the restaurant’s discretion.
The potential legal implications from service charges to restaurants extend beyond wage and hour concerns. Restaurant service charges have also caught the attention of state and federal regulators from a consumer-protection perspective. When restaurants fail to adequately notify customers that a mandatory service charge will materially increase their final bill, they risk running afoul of consumer protection laws prohibiting “surprise” or arbitrary fees and charges. Being upfront, and clearly and conspicuously communicating to customers that a service charge will be added to their bills, will mitigate any risk of a complaint that a service charge was “sprung on” a customer.
Restaurants should also avoid misrepresenting or misleading either staff or customers about whether a service charge amount will be paid to the waitstaff. For example, a service charge labeled on a bill as “mandatory gratuity” should be paid to the waitstaff to avoid misleading the customer or creating a situation where customers do not tip employees in reliance on the restaurant’s inference that the service charge is paid to the waitstaff. There are many nuances to the implementation of a service charge, so please consult with your attorney before you do.
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