Service charge and tip are not interchangeable in US operations. When teams treat them as the same bucket, pricing and payroll both drift: margin looks stronger than reality, and wage handling can become non-compliant.
This guide gives one practical sequence: classify payment type first, then price, then map to payroll and staff scripts.
Quick Summary
- IRS classification is behavior-based, not label-based.
- Mandatory or policy-dictated charges are generally service charges, not tips.
- Under FLSA, managers/supervisors cannot keep employees’ tips.
- Service-charge items should be tracked on effective check value, not base menu alone.
- State and local tip-credit rules can be stricter than federal baseline.
Why This Matters on Real Shifts
In busy Friday and Saturday windows, many stores add auto-gratuity to protect labor coverage on larger parties. That decision affects three things at once: guest communication, payroll mapping, and item-level contribution analysis. If one of those is wrong, the policy usually backfires within one pay cycle.
US Rule Baseline (Federal)
1) IRS: tip vs service charge
IRS guidance (Revenue Ruling 2012-18 framework) uses four practical tests. If a payment is not freely decided by the guest, and the amount is dictated by business policy, it can be treated as a service charge. Distributed service charges are treated as non-tip wages.
2) DOL/FLSA: tip pool and manager rules
Federal tipped-employee rules and DOL fact sheets remain clear:
- managers and supervisors cannot keep employees’ tips,
- tip-pool structure depends on whether you claim a tip credit,
- if wages plus tips do not reach required minimum levels, employer must make up the gap.
Always validate against state and city wage rules before rollout.
Pricing Math: Service-Charge-Aware Check Value
Use one standard metric in pricing reviews:
effectiveCheck = menuSubtotal x (1 + serviceChargeRate)
foodCostRate = dishCost / effectiveCheckWhen you evaluate only base menu subtotal, labor-coverage assumptions become distorted for large-party channels.
Worked Example (US)
Assumptions:
- Menu subtotal per guest:
$24.00 - Auto service charge:
20% - Dish cost:
$7.20
serviceCharge = 24.00 x 0.20 = 4.80
effectiveCheck = 24.00 + 4.80 = 28.80
foodCostRate = 7.20 / 28.80 = 25.0%If your internal target for this category is 28-30%, this check level can support labor-heavy seating periods better than base-only analysis suggests.
Local Execution: Manhattan Core vs Suburban Phoenix
| Operating context | Typical issue | Practical move |
|---|---|---|
| Manhattan high-rent full-service | Large-party turnover pressure and high labor density | Keep auto-charge policy explicit on menu and reservation confirmation; audit payout mapping weekly |
| Suburban Phoenix family-casual | More value sensitivity and mixed check sizes | Use clearer optional-tip messaging for small parties, and reserve mandatory charge for defined large-party thresholds |
One US policy text can stay consistent, but threshold and communication cadence should adapt by location economics.
POS + Payroll Setup Checklist
- Create separate POS lines for
voluntary tipandservice charge. - Map service charge distributions to payroll wage treatment before first rollout.
- Document tip-pool eligibility by role and manager exclusion rule.
- Train a one-sentence floor script for hosts and servers.
- Audit first full pay period and first month-end margin report together.
Guest-Facing Wording That Avoids Confusion
Optional model:
“A gratuity is optional and fully at your discretion.”
Mandatory service-charge model:
“An X% service charge is added for parties of N+ and is reflected on the bill.”
Consistency across menu, receipt, and verbal explanation matters more than legal-sounding copy.
20-Minute Weekly Audit Loop
- Pull top 20 checks where service charge applied.
- Compare effective check margin vs target by menu category.
- Spot-check payroll coding on one closed pay period.
- Fix either threshold or wording first, not both at once.
Related Guides
- US Restaurant Labour Cost Calculator
- US Menu Pricing Guide
- US Menu Price Rounding Guide
- US Food Cost Calculator
- US Restaurant Prime Cost Calculator
KitchenCost helps operators connect recipe cost, labor targets, and menu decisions in one workflow.