When a private club automatically adds a service charge to members' food and drink bills, does that money belong to the club or to the servers?

Plain-English summary

A private club automatically adds a service charge — a percentage of each member's food and drink bill — to its members' accounts. The club asked who owns that money for income tax purposes: the club, or the servers who wait on the members?

The Department's answer: the automatic service charge belongs to the club. The club described its own pay arrangement — until 1993 servers received a low base rate plus a share of the automatic charge, but in May 1993 the servers voted to switch to a higher flat wage (several dollars above minimum wage) and no share of the charge. Because the club keeps the charge and does not pay it out to servers, it is the club's income, and no part of it is treated as tips or wages for income tax purposes. That a customer might think of the charge as a tip does not override the club-server agreement.

The ruling also notes, in passing, that these automatic charges are part of the club's taxable gross receipts for Kansas sales tax and liquor excise tax — the point settled in In re Tax Appeal of Newton Country Club, 12 Kan. App. 2d 638, 753 P.2d 304 (1988). The club said it was already collecting sales tax on them.

What this means for you

If your restaurant or club adds a mandatory service charge, how you handle it turns on your own pay arrangement and what the charge actually is.

• Who keeps it decides whose income it is. Here the club retained the charge and paid servers a flat wage instead, so the charge was the club's income — not the servers' tips or wages.
• A "mandatory gratuity" is not automatically a tip. Despite the name, an automatically imposed charge the house keeps is business revenue, not gratuity income to the staff.
• Sales/liquor tax still applies. Automatic service charges are part of your taxable gross receipts in Kansas (the Newton Country Club rule), so collect sales tax (and liquor excise tax where applicable) on them.
• The answer depends on your contract. The Department based this opinion on the club's description of its employee agreement, not a review of the actual contract — a different arrangement (e.g., servers still share the charge) could change the income-tax result.

Common questions

Does the automatic service charge belong to the club or the servers?
To the club, on these facts. The servers are paid a flat wage and receive no part of the automatic charge, so it is the club's income.

Is the charge treated as tips or wages?
No. Because the club does not disburse the charge to its service employees, no part of it is accounted for as tips or wages for income tax purposes.

Does it matter that customers think of it as a tip?
No. A patron's view that the charge is a tip does not override the agreement between the club and its servers about wages and how the automatic charge is handled.

Is the service charge subject to Kansas sales tax?
Yes. Automatic service charges are part of the club's taxable gross receipts for Kansas sales tax and liquor excise tax — the holding of In re Tax Appeal of Newton Country Club — and the club indicated it was already collecting the tax.

Citations and references

• In re Tax Appeal of Newton Country Club, 12 Kan. App. 2d 638, 753 P.2d 304 (1988) — the Kansas Court of Appeals upheld the Department's position that automatically imposed service charges are part of the taxpayer's gross receipts and must be included in the tax base for Kansas sales tax and liquor excise tax.

Source

• Original ruling (DOCX): https://www.ksrevenue.gov/pildocs/rulings/P-1999-45.docx
• Kansas Policy Information Library: https://www.ksrevenue.gov/prpil.html

Original ruling text

Private Letter Ruling

Body:

Office of Policy & Research

March 1, 1999

XXXX
XXXX
XXXX

RE: Your letter dated January 6, 1999

Dear XXXX:

I have been asked to answer your letter that we received last month. In it you ask if service charges that are automatically billed by a private club (the “Club”) to its members as a percentage of food and drink charges should be treated as belonging to the club or belonging to the servers for income tax purposes.

Automatically imposed services charges are sometimes called mandatory gratuities, which is somewhat of a oxymoron. The Kansas Department of Revenue litigated whether such charges are subject to sales tax in In re Tax Appeal of Newton Country Club, 12 Kan. App. 2d 638, 753 P.2d 304 (1988). The Kansas Court of Appeals upheld the department’s position that these charges are part of the taxpayer’s gross receipts and must be included in the tax base for Kansas sales tax and liquor excise tax.

Your question does not involve sales tax, which you indicate the Club is collecting on the service charges. You ask whether these charges belong to the Club or to the servers. You state:

At one time the Club distributed a portion of these automatic charges to its servers. In May of 1993 the servers voted approval of a change in their own method of compensation so that instead of a low base rate and a share of the automatic charge, they received a higher flat rate several dollars in excess of the state and federal minimum wage, but no portion of the automatic charge.

This statement indicates that the automatically imposed service charge belongs to the Club and, therefore, are proceeds of the Club rather than proceeds of the servers for purposes of income tax. This is consistent with the rationale expressed in In re Tax Appeal of Newton Country Club. No part of the receipts should be accounted for as tips or wages for income tax purposes since the Club does not disburse the receipts to service employees.

The fact that a patron may view the service charge as being a tip would not overcome the agreement between the Club and the servers about wages and treatment of the automatic service charge. These charges are part of the Club’s income. Therefore, no part of the receipts should be treated as tips or wages for income tax purposes.

Please note that this opinion is based on your description of the contract between the Club and its employees rather than on a review of the contract itself. It assumes that you have provided all the material facts required to form an accurate opinion. I hope that the discussion adequately answers your questions. If not, please call me at (785) 296-3081.

Sincerely,

Thomas E. Hatten

Attorney/Policy & Research

Date Composed: 03/17/1999 Date Modified: 10/11/2001

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