August 24, 2005
Tip or Service Charge? Part II

After my previous post on this subject, I received the following email from Gary Reed. He makes some really good points about the difference between a tip and a service charge. Thanks Gary
Boy, isn't that the question? Is a tip a service charge? That's what many restaurants want us to believe, isn't it?
What does replacing voluntary tips with a service charges actually mean?

Lets start off by understanding that tips and service charges are both defined under federal law. Did you know that federal regulations state that a tip is to be distinguished from a payment of a charge, if any, made for the service? Do you know why? You see it would be fraud if a customer gave a tip to an employee and the business owner kept it for himself or controlled that money to his own benefit. Service charges are not tips. Service charges may be kept by the business owner. Did you know that?

Here is a link to the law which explain that service charges are the property of the employer.

You see it clearly says that service charges are amounts received from customers that are the employer's
property, not the employees, such amounts do not constitute tip income to the employee.

Now that we understand what service charges are, let's understand what tips are.

Here's a couple of link which explain clearly what tips are.
As you may note in the first link A tip is a sum presented by a customer as a gift or gratuity in recognition of some service performed for him. It is to be distinguished
from payment of a charge, if any, made for the service. Whether a tip is to be given, and its amount, are matters determined solely by the customer, and generally he has the right to determine who shall be the recipient of his gratuity.

Now on to the second link which clearly explains; Retention of Tips: The law forbids any arrangement between the employer and the tipped employee whereby any part of the tip received becomes the property of the employer. A tip is the sole property of the tipped employee.

So now lets get back to the question at hand. Is a tip the same as a service charge?

Now let's move on to a few more pertinent and revealing questions.

1. Why are restaurants replacing a tip with a service charge?

2. What does replacing voluntary tips with a service charges actually mean?

3. Is it legal?

1. Isn't it clear when one has an understanding of what tips and service charges actually are that the reason restaurants want to replace tips with service charges is so customers will give the business money that they used to give the employees. Remember tips are the sole property of the tipped employee, that means that moneys received as tips can't be used by the business. On the other hand, moneys received as service charges are the business's property and as such the business can do what ever they want to do with those moneys according to federal law.

2. Replacing tips with service charges actually means that customers will be giving the business money instead of the employees. Remember, under federal law service charges are the business property not tip income for the employees. What will actually happen is that the money that used to be given to the employees will become by law the employer's property. What this means to workers is that the tips that they used to receive from customers and which were protected by federal laws as their sole property will become property of their employer. What this also means is that a customer's right to determine whether a tip is given, the amount and who will be the recipient of his tips will be replaced by an automatic charge which denies customers their right to determine such matters and which results in the business fraudulently reaping the financial rewards of the tip that would have gone to an employee of the customer's choosing.

Why do I state that it is fraudulent? Most customers who pay these service charges think they are the same thing as a tip. In fact, many restaurants openly suggest that the service charge is in lieu of a tip. What is in lieu. Alternately, alternatively, by choice, by preference, first, in lieu, in preference, instead. Business want customers to instead of tipping their employees to give the business additional income.

3. Is it legal.
I do not think so. Customers are being led to believe that a service charge may be paid in place of a tip, however no distinction is being made that the service charge is not the same as a tip. Many customers are paying these service charges with a misguided impression that a service charge is the same as a tip when clearly there are distinct differences. Customers, in fact, are paying service charges that they think are money intended as tips not knowing that the money is legally the business's. I truly believe such practices are fraud on the consumer and not only fraud but intentional fraud. Businesses have every right and ability to charge more for their services if additional income is needed. Instead of charging more for their services many businesses are intentionally substituting service charges for tips in an effort to defraud money out of the public.

You can write whatever you want about service charges, but I am telling you right now they are nothing but fraud when they are accessed in lieu of a tip without distinguishing that they are not actually a tip.

Businesses have been attempting to steal the tipped employee's tips for decades. The service charge is just another blatant attempt.

Gary Reed and millions of tipped employees nationwide

Posted by at 10:33 PM in Economics ~ in Law  ·  TrackBack (0)


What a load of nonsense. While it is not explicitly stated, it is implicit in the entire proposal to replace tips with service charges that the staff will be paid more in leiu of tip income. Any restaurant that didn't would quickly find itself without waiters and waitresses.

Posted by: Dan Hill at August 24, 2005 11:10 PM

Ceteris paribus, tipped employees lose if tip transactions between customers and themselves go through an extra step or middle-man.

Mr. Reed is correct. I worked at a restaurant as a busser where more than half of my income came from tip-share.

Employers profit from service charges because they skim benefits gained by servers through their special relationship with customers. To me it smells of fraud, or at least harnesses a relationship in a way that it historically wasn't intended to be used.

Without any hint of bias, however, it could simply be called an attempt toward optimization on the part of restaurant owners, but as Mr Frasca pointed out in his first post it may shake up the market and lead to unfavorable consequences.

Posted by: David Rossie at August 25, 2005 12:30 PM

In a competitive market, wages should approximate MPL. So it shouldn't matter who receives the tip. If take home compensation declines because of "skimming" of service charges by owners, waiters with higher MPLs will migrate to restaurants without service charges, or other occupations.

Posted by: Josh Hall at August 25, 2005 09:27 PM

Dan, you stated that what I wrote was a load of nonsense. You went on to state that while it is not explicitly stated, it is implicit in the entire proposal to replace tips with service charges that the staff will be paid more in leiu of tip income. Any restaurant that didn't would quickly find itself without waiters and waitresses.

Do you really think the staff, that is the ones who actually receive tips from customers, are going to earn more money when the business owner is allowed to determine who should receive this money customers have been deceived into believing are tips? Busniness owners will distribute the tips to as many workers as they can, if they don't simply keep it for themsleves, so that the business can offer lower wages to all their employees. Is that what tipping is? Giving the business money so that it can pay lower wages to it's employees? I don't think so. Tips are given to an employee with the knowledge that his employer is most likely paying him very little. A tip is in addition to the low wages his employer is most likely paying him.

If customers are tricked into paying a service charge instead of a tip the money is legally the business's property to use however the business sees fit. Walmart has a similar set up where the employees are simply paid whatever the business sees fit. Is that what you think service jobs should be turned into? Walmart, even though they pay low wages doesn't seem to have a problem getting and retaining workers. It seems like most businesses in this country are opting to pay lower wages so that they can make more profits for themelves and their CEO's.

I think it's a load of nonsense to beleive that if the tip is replaced by a service charge that employee's earnings will increase. The money that was legally the property of the tipped employee will become by law the property of the employer and employees will be left at the mercy of their employer to keep their wages up with inflation. Businesses in our country have shown quite convicingly that they have no concern for keeping wages up with infoation when it cuts into their profits. As far as keeping good workers goes, I don't think most businesses want good workers. They only seem to care about obtaining cheap labor. Look the imigration problem that we are now witnessing. Bussinesses are the biggest lobbiests for allowing illegal imigration. Look at how many business are moving their business to other countries where labor is cheaper. They don't sem to care about having good workers now do they. That's what this service charge crap is all about. Getting cheap workers. If they can take away the tips their current employees are receiving from the public they can utilize those moneys to pay their payroll expenses and increase their earnings. It's really pretty clear cut.

Posted by: Gary at August 29, 2005 01:44 PM

Sorry, canít get trackbacks working today. Long post on the tax implications here:
Service charges greatly increase the tax paid.

Posted by: Tim Worstall at September 3, 2005 06:59 AM

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it. -Adam Smith

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