Gratuity and tips are often confused. As a consumer, you’re more concerned about having to pay more for the service that you receive than anything else. However, there’s a major difference between the two.

What are the differences?

Restaurant owners and managers need to know the legal ramifications of charging automatic gratuities and what it means for their establishments.

tips usa restaurant

Automatic Gratuity vs Tip

Gratuity vs tip restaurants have unique definitions, and if you’re considering charging an automatic gratuity, there are quite a few things that you need to know ahead of time.

What is a Tip?

Tips are – tips. When a patron receives their bill, they have the option to leave a tip to the waitstaff. Customers may leave no tip at all, but if the service is good, they may leave 15% - 25% additional on top of the bill.

Everyone has a right to leave a tip that they see as justifiable, but most will:

  • Calculate the tip as a percentage of the bill (i.e., 15% on a $100 meal would be $15). Some customers use a restaurant tips calculator for this purpose.

Many restaurants take the math out of the equation and will list how much tip to leave at the bottom of the receipt if you want to leave a 15%, 20% or 25% tip.

You – and the IRS – view tips as a “gift.”

Restaurants do not add the charge to the bill, so the customer is under no obligation to pay it, unlike a gratuity vs service charge.

What is an Automatic Gratuity?

A service fee vs gratuity that’s charged automatically is somewhat different, too. Often, a service fee is added to every bill, no matter how large the part may be. Gratuity charges that are automatic are often:

  • Applied in certain situations

  • Not a tip nor gift

Restaurants often add automatic gratuity for large groups because they want servers to be compensated for the additional time it may take to serve them. For example, if a group of eight people go into a restaurant, they are often charged automatic gratuity.

But since this is an automatic charge, it is considered a service charge and not a tip.

Diners do not have the option of not paying the charge because it’s compulsory. However, there are legal requirements that must be met (more on that in the law section below) to be able to charge this fee.

What Is the Difference Between a Service Charge and Tip?

We’ve seen the main difference between a service charge vs gratuity, but what about a tip? If you’ve been reading along, you probably guessed it:

  1. Service charges are set by the restaurant and are compulsory. You must pay this charge.

  2. Tips are not set by the restaurant and there’s no compulsion to pay them.

The Auto Gratuity Law

You cannot charge an auto gratuity without alerting the consumer to the charge. The IRS requires that if a restaurant does have an auto gratuity charge, it must be considered a fee. Why? Consumers are obligated to pay the fee even if they disagree with it.

While these fees are legal, you do have to rely on state law to know what you must do to alert the consumer about the fee.

Many, but not all, states have laws stating that either:

  • Gratuity fees should be mentioned clearly on the menu

  • Servers must inform the party of the fee

Gratuities must be claimed on the employee’s taxes and are a part of their regular paycheck. If auto gratuities are always charged, the employee’s income must be equal to the state’s minimum wage.

restaurant management tips

2 Types of Tips

There are two main types of tips in a USA restaurant:


Cash tips are the most common type of tip given at a restaurant. These are monetary tips given directly to the server from the customer, either in cash or via credit/debit card charges.

Tips received from tip-sharing arrangements also fall into this category. It's common for servers to share a portion of their tips with service bartenders, hostesses and bussers.


Just as the name suggests, a non-cash tip is a tip in the form of goods and commodities, such as tickets or physical items of value.

Please Note: Restaurant management tips and restaurant manager tips (directly or through tip pools) are not legal based on U.S. Department of Labor laws.

Knowing these two types of tips will help you understand tip reporting laws.

Tip Reporting: What You Need to Know

Another complicated aspect of tipping is reporting. As a restaurant owner, it’s important to understand the rules and regulations to ensure your business is compliant.

Here’s what you need to know:

Employees Must Report Tips

For tax purposes, employees are required to report all tips as gross income, including cash and non-cash tips. But employees must also report all cash tips (over $20 in any given month) to their employers. They are not, however, required to report non-cash tips to employers.

If a customer leaves a server a piece of jewelry as a tip, the server must report the jewelry to the IRS, but is not required to report it to their employer.

Employers Must Keep Tip Reports

Employers are required to keep employee tip reports for tax purposes. They’re also required to pay their share of Medicare and Social Security taxes based on the total wages paid to tipped employees and reported tipped income.

Employers Can Leverage the “Tip Credit” Rule

Once a tip goes into an employee’s pocket, it cannot become the property of the employer. However, the Fair Labor Standards Act (FLSA) does allow an employer to take a tip credit towards their minimum wage obligation, up to $5.12 (the difference between the federal minimum wage of $7.25 and the required cash wage of $2.13).

Tip credits can never exceed the actual amount of tips an employee receives. The law also states that employers cannot apply the tip credit unless the employee is notified.


Tips, gratuities, service charges – these terms can be confusing to restaurant owners. But it’s important to understand what each term means and their differences to avoid non-compliance or breaking the law.

Consider consulting with a lawyer and tax professional to ensure your restaurant is using the best practices for handling and reporting tips.