Is a stated 10–15% restaurant service charge taxable when it is labeled a gratuity and paid entirely to the employees?

Plain-English summary

Food Systems, Inc. operates a dining facility. Its bills to customers include a stated service charge of 10% or 15%, and the entire amount is paid over to the employees, whose wages are below the minimum wage. It asked whether these charges — shown as gratuities on the bills — are subject to State and local sales tax.

The Department held the service charges are not taxable, because they meet the gratuity exclusion.

• Charges to a food/drink customer are taxable unless the gratuity test is met. Under 20 NYCRR § 527.8(e), any charge made to a customer is taxable as a receipt from the sale of food or drink unless all three conditions are satisfied:
  1. the charge is separately stated on the bill or invoice given to the customer;
  2. the charge is specifically designated as a gratuity; and
  3. all such monies are paid over in total to employees.
• This restaurant satisfies all three. The service charge is separately stated, designated a gratuity, and paid over entirely to the employees.
• Result: not taxable. Because the procedures meet the regulation, the service-charge revenues are not subject to tax.

What this means for you

A mandatory service charge can escape tax — but only if you meet every condition. New York treats a service charge on food or drink as part of the taxable bill by default. It becomes a nontaxable gratuity only when it is separately stated, clearly labeled a gratuity, and handed over in full to the staff. Miss any one of the three and the charge is taxable.

"Paid over in total" means the whole amount goes to employees. If the house keeps any part of the service charge, the exclusion fails and the full charge becomes taxable. Keep records showing the money flowed entirely to the workers.

Label it clearly on the check. Vague "service" wording or burying the charge can defeat the exclusion. The regulation wants a charge that is both separately stated and specifically designated a gratuity.

Common questions

Q: We add an automatic 15% charge and give it all to our servers. Is it taxable?
A: No — provided it is separately stated on the bill, specifically designated as a gratuity, and paid over in full to employees. Meeting all three conditions of § 527.8(e) makes it nontaxable.

Q: What if we keep part of the service charge for the house?
A: Then the third condition fails. The charge is not fully "paid over to employees," so it is taxable as part of the food-and-drink receipt.

Q: Does it have to be broken out separately on the check?
A: Yes. It must be separately stated and specifically designated as a gratuity, in addition to being paid over entirely to employees.

Citations and references

Regulations:

• 20 NYCRR § 527.8(e) — gratuities and service charges on sales of food and drink are taxable unless separately stated, designated a gratuity, and paid over in total to employees

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1983.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a83_24s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-83(24)S
Sales Tax
May 24, 1983

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S820817B

On August 17, 1982 a Petition for Advisory Opinion was received from Food Systems, Inc.,
3300 Transit Rd., West Seneca, New York 14224.
The issue raised is whether charges to customers which are shown as gratuities on the bills
presented to such customers are subject to New York State and Local Sales Tax.
Petitioner is the operator of a dining facility. Bills to customers include a stated service
charge of either ten or fifteen per cent. The revenues so received are paid over in toto to the
employees, whose salaries are below the minimum wage.
Section 527.8(e) of the Sales and Use Tax Regulations, applicable to sales of food and
drink, provides as follows:
"(l) Gratuities and services charges. Any charge, made to a customer, is taxable as a
receipt from the sale of food or drink unless:
(i)

the charge is separately stated on the bill or invoice given to
the customer; and

(ii)

the charge is specifically designated as a gratuity, and

(iii)

all such monies received are paid over in total to employees."

Inasmuch as the procedures described herein satisfy the criteria sat forth in the above-quoted
provision of the Sales and Use Tax Regulations, the revenues received as service charges are not
subject to tax.

DATED: May 9, 1983

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

s/FRANK J. PUCCIA
Director
Technical Services Bureau

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR