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New tax treatment of tips and service charges

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in Small Business Tax

A little-noticed rule change for restaurants and similar establishments could have a big impact next year. Beginning in 2014, automatic gratuities charged for large parties will be treated as “service charges,” triggering new payroll requirements.

Initially, the IRS intended the rule to take effect in 2013, but it was persuaded to postpone implementation for a year. (IRS Revenue Ruling 2012-18, Announcement 2012-50) Now it says it’s going full steam ahead in 2014. Because automatic gratuities will be treated as wages, employers will be required to withhold income tax on the payments, as well as adjusting hourly pay rates of employees to reflect the change. Also, the rules might cause conflicts with state tax laws. Consult with a tax pro if this affects your business.

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