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Tips Versus Service Charges


Rules for tipping employees are increasingly complicated and opaque (“Americans Are Confused, Frustrated By New Tipping Culture, Study Finds,” The Washington Post, November 9, 2023). Part of the problem is the rise of mandatory “service charges” that some restaurants add to large-party banquets and online orders. But while they may seem similar (sometimes by design), tips and service charges are fundamentally different. Knowing the difference is critical, since tips belong to employees whereas service charges can be kept by employers.

  1. Tips and service charges compensate for different things
  2. Tips are additional monies, above and beyond the costs of the goods and/or services received, that customers voluntarily pay to compensate employees for providing the services. Pursuant to California Labor Code Section 351, tips belong solely to employees and may not be deducted to offset costs related to the tips (e.g., credit card processing fees). They also cannot be shared with owners and/or managers, although they can be pooled and shared among non-management co-workers who assist with providing the services for which the tips are given (e.g., bussers, bartenders, etc.).

    In contrast, service charges are assessed to cover additional costs arising from special events and/or orders. Service charges are mandatory and are therefore not voluntarily gratuities. True service charges belong to employers and need not be shared with employees (although they can be shared, in whole or in full, if employers choose to do so).

  3. How to differentiate tips from service charges
  4. Employers are responsible for clarifying that additional payments customers make are in fact service charges and not gratuities. Given the sacrosanct nature of employee wages, any ambiguities will be interpreted against employers and purported service charges can be deemed de facto tips owed to employees.

    Much will depend on how employers depict the payments and who they will go to. The best-practices for ensuring that payments will be treated as service charges are to have contracts and/or other written disclaimers specifically calling them “service charges” and informing customers that they will go to the employers. Conversely, calling the payments tips or gratuities suggest that they will go to employees.

    Payments that customers make voluntarily are also more likely to be considered tips, even if the customers are prompted to make the payments (e.g., with fields on order forms asking if customers want to pay additional amounts). Likewise, if customers are required to pay certain minimum amounts but voluntarily pay more, some portion of the payments may be considered service charges and some tips.

  5. Impact on other pay
  6. In California, certain payments to employees can impact other aspects of their pay. For example, when employees receive certain types of pay, including bonuses, those payments must be added to the employees’ base pay to calculate overtime rates. In other words, when employees receive bonuses, their overtime rates can increase.

    Tips and gratuities generally do not change employees’ overtime because the payments are made voluntarily by customers, not employers. But when customers pay service charges to employers that the employers then opt to share with their employees, those payments can impact employees’ overtime rates because they are generally considered to be bonuses.

    The distinction between tips/gratuities and service charges is a complicated issue that can have significant stakes for employers and employees alike. Please contact the Nelson Law Group if you have any questions about this evolving area of the law.