Restaurants and Good Intentions Meet the Tax System

(Image from waitbutwhy.com)

Eliminating tips--and raising menu prices and wages to compensate---seems like a good idea. By embedding the tip into the wage the restaurant gets to say that it has "raised" the pay rate from, say, $12.50 to $15, thereby complying with higher minimum wage mandates. The restaurant also can distribute the tips more evenly among the waiters, the cooks, and the staff. And customers shouldn't mind because their outlay stays about the same.

Moving compensation from one category to another, however, proves to be no free lunch [bold added]:

when Sous Beurre Kitchen opened in the Mission in February, [owner Michael] Mauschbaugh followed the example of five Bay Area restaurants that abandoned tipping in late 2014. He printed all-inclusive prices on his menu, which allowed him to pay his kitchen staff well above minimum wage and offer health insurance.

This October, though, Mauschbaugh abandoned the tipless model and issued pay cuts. “We got overrun with taxes, and it became unsustainable,” he said.

Sales taxes (8.75% in San Francisco) are imposed on the higher tip-included bill; the customer pays the additional tax, but neither the restaurant nor its employees see the benefit. There are also numerous costs that are tied to base wages, e.g., unemployment insurance, workers compensation insurance, Social Security taxes, and State Disability insurance. (Some costs also are higher because total compensation is accurately reported, while tip income had been under-reported by waitstaff .)

Restaurants with well-intentioned ideas meet the tax system, discover that these ideas increase costs significantly, and eventually the changes are abandoned. Unfortunately, their experience is not a rare phenomenon.

Related: Restaurants are eliminating auto gratuities (typical example: 18% service charge automatically imposed on parties of eight or more).

TGI Fridays — and most other large restaurant chains — got rid of auto-gratuities entirely. The reason: A new rule from the Internal Revenue Service that counted those mandatory charges as wages, making them subject to payroll taxes and a factor in overtime calculations.